How to correct an excess HSA contribution that was made years ago ?

[Chena]

How can I correct an excess HSA contribution that occurred in 2019 but was not addressed before filing my 2019 taxes ?

For example, if I contributed $100 too much in 2019 but did not correct it before filing of 2019 or 2020 taxes.

Currently TT tells me it is too late to correct it by withdrawing it now.

How can I, in 2022, correct the excess HSA contribution that occurred in 2019 (and do it in a way that makes it clear this is correcting the excess 2019 contribution and not just making an unqualified withdrawal) ?

I have not been in a high deductible medical plan since the time of the excess contribution thus no additional contributions have been made to the HSA since 2019.

[FangxiaL]

Usually, excess HSA contributions are withdrawn before the deadline of the tax return.

However, if you made an excess HSA contribution in a prior year and didn't withdraw it before the deadline, you are no longer able to withdraw the excess contribution. The excess contribution counts as a contribution in future years, which can continue to create penalties in future years as well if it continues to exceed your allowable contribution amount.

Here are a few options for getting rid of an excess contribution that's continuing to accrue penalties year after year:

• You can simply take a nonqualified withdrawal of the excess amount. This distribution will be taxable and subject to a 20% penalty.
• You can take qualified withdrawals (for medical expenses) that take your HSA balance to $0. The penalty is assessed on the lower of your excess contribution or your HSA balance at the end of the tax year. By drawing the account down to $0, you will have no more penalty assessed.
•  You can change your health insurance plan back to an HDHP that is HSA-eligible again. This will allow you to use up the excess contribution.

[Edited on 3/8/2022 | 8:15PM,20 PST]

[Chena]

The HSA is with Fidelity. They say I can make a withdrawal request but there is nothing on the form for indicating it is an Excess Contribution Removal request. For excess contribution withdrawals there is a different form, but they say I cannot use that form because the excess contribution was made in 2019.

Thus, it is not clear how to get them to issue a 1099-SA with box 3 marked as 2 (excess contribution).

I wonder if I made a regular withdrawal that Fidelity marked as distribution code 1 (normal withdrawal) there would be a way when doing taxes to indicate that Fidelity got the distribution code wrong and that is was really an excess contribution withdrawal.

[Mike9241]

leave the money in a pay a 6% penalty each year based on the lower of the excess ot HSA year end value.

make a nonqualified distribution - income taxes and 20% penalty.

pay medical expenses to reduce balance in a/c but see the first line

make less on a current year contribution so the prior excess and the current year contribution does not  exceed your max

[Chena]

I had read that some potential solutions to this were:

* spend down the entire HSA account to zero

   Not something I'm ready to do, although not in a high deductible medical plan since 2019 (the date of the excess contribution) , I'm still letting it accumulate until needed in later years

* rejoin a high deductible plan

   Not possible as our current retiree plans do not offer a high deductible plan

* make a unqualified distribution

   This is the option I would like to execute but it seems problematic. Fidelity won't process it as an excess contribution withdrawal, so the resulting 1099-SA will have an incorrect distribution code reported. I'm not sure what happens if I do this, letting the 1099-SA indicate distribution code of 1 (normal withdrawal) but try to correct that when filing taxes. Unclear if 1099-SA is reported to IRS and if they cross-check against the return.

I did find that for calculating the earnings attributable to the excess contribution one is to follow CFR 1.408-11. The calculation used for returned or re-characterized IRA contributions.

Thus, I can determine the correct values that would belong in box 1 (gross distribution) and box 2(earnings on excess cont)  and box 3 (distribution code - 2 for excess contribution) --- but this would not match what Fidelity wants to create as they only seem firm they can't process an excess contribution withdrawal for me.

[Dasstc]

I cannot believe you have exactly the same problem I do at the same institution. 

I had an excess contribution in 2019 to a Fidelity HSA that I cannot correct as well.  I filled out the Fidelity Return of Excess Contribution to form (download from Fidelity) and mailed it.  They returned the form to me and included a letter to call them.  

I called them today and they said they can only go back to 2021 to remove excess HSA contributions!  They said I need to consult a tax specialist.  I'm very frustrated.  I think Fidelity needs to process this and issue the correct IRS form to me for taxes this year.

[Chena]

Yes, they simply tell me to consult a tax accountant to claim the excess contribution. At this point, I plan to just pay the small fee TT says I owe on taxes due to the excess contribution for my 2021 taxes. After tax season is over, I will try to find a tax preparer or CPA and see if for $50 they will have a 15 minute conversation to tell me how I can make the excess withdrawal -- I'm hoping I can just do a "normal" withdrawal and then on my 2022 taxes indicate that the 1099-SA issued was incorrect.

It will be interesting and more than frustrating if they tell me that Fidelity should be able and willing to remove the excess contribution even after a few years of it being in the account.

[Dasstc]

Maybe we fudge the form and say the contribution was in 2021 just to get Fidelity to process the form.  

I'll be interested if you find a better solution!

[FangxiaL]

Here are a few options for getting rid of an excess contribution that's continuing to accrue penalties year after year:

• You can simply take a nonqualified withdrawal of the excess amount. This distribution will be taxable and subject to a 20% penalty.
• You can take qualified withdrawals (for medical expenses) that take your HSA balance to $0. The penalty is assessed on the lower of your excess contribution or your HSA balance at the end of the tax year. By drawing the account down to $0, you will have no more penalty assessed.
•  You can change your health insurance plan back to an HDHP that is HSA-eligible again. This will allow you to use up the excess contribution.

@Dasstc

[Dasstc]

Thank you!  I'll try your first option.

[Chena]

Hi @FangxiaL 

Please provide more details on the process for taking an nonqualified withdrawal of the excess amount.

In particular, my understanding is that we need to withdraw the excess amount AND the earnings attributable to that excess amount.

Additionally, the 1099-SA we receive as result of the withdrawal will indicate a distribution code of "normal withdrawal" and not a "excess contribution withdrawal".

How will the IRS understand that we are correcting the excess contribution ?

[Dasstc]

@Chena I was wondering the same thing, principal + earnings needs to come out.  I assume that is the way an excess contribution would have been handled by Fidelity (per IRS rules) had we done it in in 2019.   

Like you said, a non-qualified/normal distribution won't be coded the same as an excess distribution on the 1099-SA. They are not equivalent.  So we will, yet again, be left with another year of carryover to pay the penalty on.

[Opus 17]

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@Chena wrote:

I had read that some potential solutions to this were:

* spend down the entire HSA account to zero

   Not something I'm ready to do, although not in a high deductible medical plan since 2019 (the date of the excess contribution) , I'm still letting it accumulate until needed in later years

* rejoin a high deductible plan

   Not possible as our current retiree plans do not offer a high deductible plan

* make a unqualified distribution

   This is the option I would like to execute but it seems problematic. Fidelity won't process it as an excess contribution withdrawal, so the resulting 1099-SA will have an incorrect distribution code reported. I'm not sure what happens if I do this, letting the 1099-SA indicate distribution code of 1 (normal withdrawal) but try to correct that when filing taxes. Unclear if 1099-SA is reported to IRS and if they cross-check against the return.

I did find that for calculating the earnings attributable to the excess contribution one is to follow CFR 1.408-11. The calculation used for returned or re-characterized IRA contributions.

Thus, I can determine the correct values that would belong in box 1 (gross distribution) and box 2(earnings on excess cont)  and box 3 (distribution code - 2 for excess contribution) --- but this would not match what Fidelity wants to create as they only seem firm they can't process an excess contribution withdrawal for me.

---

First, you need to file an amended 2019 return that reports the excess and you will pay income tax plus a 6% penalty on the excess, if you did not already report it.

Then, you need to file an amended 2020 return that pays a continuing 6% penalty on the excess, if you never withdrew it.

You also need to report the continuing excess on your 2021 return and pay a 6% penalty.

Then for 2022, simply take a regular withdrawal.  There is no special distribution code on the 1099-R, it's a regular withdrawal.  When you file your 2022 tax return, you will report the total of your withdrawals, and when the program asks "was all the money used for qualified expenses", answer no.  The program will ask for your qualified expenses.  The excess will be assessed income tax plus a 20% penalty, but will remove it from future treatment as an excess contribution.

For example, if your medical expenses in 2022 are $1500, and the excess contribution in 2019 was $100, you will withdraw $1600 for 2022 (before December 31).  When the program asks about your qualified expenses and you report $1500, the excess will take care of itself.  But this will only work if Turbotax knows you have a $100 excess contribution from a prior year, and it will only know this if you tell the program specifically, or if the program imports your 2021 tax return that also reports the excess. 

[Opus 17]

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@Dasstc wrote:

I cannot believe you have exactly the same problem I do at the same institution. 

I had an excess contribution in 2019 to a Fidelity HSA that I cannot correct as well.  I filled out the Fidelity Return of Excess Contribution to form (download from Fidelity) and mailed it.  They returned the form to me and included a letter to call them.  

I called them today and they said they can only go back to 2021 to remove excess HSA contributions!  They said I need to consult a tax specialist.  I'm very frustrated.  I think Fidelity needs to process this and issue the correct IRS form to me for taxes this year.

---

No, you can't "remove an excess contribution" after October 15 of the following year.  That's a special procedure and you can't use it now.

Make sure that the excess is reported on your 2019 return.  You will pay a 6% penalty on form 5329.  If the excess was not reported, you need to amend your 2019 return.  You must also pay the 6% penalty on your 2020 and 2021 return.

To remove the excess now, you just have to withdraw more than your medical expenses.  It will be an ordinary withdrawal with a normal distribution code on the 1099-SA.  There's no special code or procedure.  For example, if your medical expenses in 2022 are $1500 and the excess was $100, you need to withdraw $1600. When Turbotax asks "did you spend all the money on qualified expenses", answer no.  Enter the amount of your qualified expenses.  The excess will be placed on form 5329 and you will pay a 20% penalty, but it will also zero out the issue of a prior year excess contribution.

[Opus 17]

@Chena 

@Dasstc 

No, the earnings on the excess does not have to come out.  That procedure only applies if you are withdrawing the excess before the tax filing deadline of the year in question.  Now, you just withdraw an extra amount not for qualified medical expenses and pay the 20% penalty.  

Let me try and explain it this way.  If you made an excess contribution in 2019, you could withdraw it before the tax deadline for that years tax return (October 15, 2020).  To withdraw the excess, you have to make it as if the excess was never contributed, and that means withdrawing the earnings as well.   However, since you left the excess in the account, it did happen, and as a result, you paid tax plus a 6% penalty, ongoing until you remove the excess.  You can't withdraw it "as if it never happened", it's too late.  The 6% penalties, and the 20% penalty, are more than the tax you would have paid on the earnings.  The earnings (if any, most HSAs don't pay much) stay in the account and don't have to be removed.