How to resolve Excess HSA Contribution from 2020

[Richbarbhamm]

I retired at the end of 2020.  As a result, I was moved off my employee sponsored HSA plan to regular co pay type of coverage for 2021.  I also rolled over the HSA from the Company plan to a Fidelity HSA.  In 2020 I was trying to load up my HSA prior to retirement.  As such I over contributed by $900 by mistake as I only qualified for 11/12ths of the year to make contributions due to timing of retirement.  My High Deductible plan ended in Nov 2020.   

When I completed the taxes last year, the program provided guidance that I would pay a 6% penalty.  I figured no problem, I’ll just let the money work till we need it.  Unfortunately, the guidance didn’t indicate that I should have just resolved at that time or I would have the same issue in the following year.   

Now, for 2021, I have the same penalty and the program indicates that I can no longer just withdraw to correct the overfunding (as I could have last year).  So, what is the best way to resolve?  Can I use our HAS card for $900 of medical expenses in 2022 to resolve?    

[RaifH]

No, you can't use your HSA for medical expenses to resolve the over-contribution from a prior year. 

Instead, you would have to mark the $900 specifically as not for medical expenses. That would make this $900 withdrawal a taxable distribution that will be included in your ordinary income. You would also be subject to a 20% penalty on this distribution if you are not over the age of 65 or disabled. 

If you already received a 1099-SA for the amount you spent in 2021, and you want to remove the excess contribution so you do not have to deal with it in future years, you can enter $900 as a non-qualified expense. For example, if you withdrew $1,500 from your HSA and received a 1099-SA, after entering it:

1. Did you spend your HSA money on medical expenses only? No, I didn't
2. In the Amount used for medical expenses field, enter 600 (1,500 distribution minus 900 taxable distribution). Leave the Amount rolled over field blank

[Richbarbhamm]

Thank you RaifH.  

We actually did not have any HSA expenses in 2021, thus no 1099-SA.   

I already have a sizable hit this year (2021) due to sale of investment property.  So, could I withdraw the $900 in that is in excess during 2021 and address, pay penalties during the 2022 tax season?  Next year I will have the ability to do some tax loss harvesting on stock sales that could be used to offset (sales made in 2021 in long-term holding).   

Does that sound like a reasonable strategy or will the tax penalties compound?

Regards, Richard    

[BillM223]

First, you pay the 6% penalty for the carryover amount for any year in which your HSA is not zero. To be more accurate, the 6% penalty is times the lesser of the HSA balance or the carry over. So when the HSA balance goes to zero, no penalty.

If you withdraw the $900 in 2021, this goes on your 2021 tax return (NOTE: you have to do this before April 18th (unless you file an extension). If it goes on your 2021 tax return, the $900 will be declared as Other Income in 2021 and you will owe the 20% penalty in 2021.

If you let the excess carry over until 2022, you will pay another 6% in 2021, but the Other Income and 20% penalty may be swallowed up in your losses on stock sales. I can't say more, not knowing your 2022 situation.