HSA distribution in 2021 that was partially refunded in 2022

[Diane_]

Hello,

My daughter was hospitalized in late 2021, and the "finance lady" came around to her room to collect payment from me. Not understanding how "the system" works, I paid them out of my two HSA accounts. Turns out they just demanded the remainder of my out of pocket maximum for the year (around $5500) and I was too upset and naïve/stupid to say no or to negotiate a reasonable payment amount.

I thought the hospital would apply my up-front payment to the actual bills, however they only kept around $1600 to cover their first invoice, and refunded the rest back to my two HSA cards in January. Then they sent me an additional invoice for around $1300 at end December, which I paid in January (but not directly out of my HSA).

Problem is that the payments were in 2021 and the refunds that came directly back to the HSA accounts occurred in 2022. I now have a hospital statement to cover only $1600 of the $5500 that was disbursed in 2021 (even though the remaining $3900 was refunded back to my accounts in 2022). I called both HSA banks and they both said they could not apply the reimbursements back to the 2021 tax year.

I'm totally lost on how to handle this for 2021 taxes. Do I now have to report the excess hospital payment of $3900 as a personal distribution for 2021 (incurring income taxes and penalty), even though I got the money back in 2022? I do have receipts from the hospital for the payments totaling $5500 in 2021, but an itemized statement for only $1600 against that payment. My 1099-SA includes the full $5500 in the "gross distribution" amount. 

Looking forward to some advice, if anyone can help! Thank you!

[Mike9241]

The IRS allows an HSA owner to “correct” the mistake by returning the distributed amount to the HSA and treating it as though the distribution never occurred. An HSA owner has until April 15 following the first year the HSA owner knew (or should have known) that the distribution was a mistake to repay the assets to her HSA. contact the HSA's again and tell them the money returned was a mistaken distribution to see if they'll issue corrected forms.

however, the IRS also says

Must we report the mistaken distribution to the IRS?
No, according to the Instructions for Forms 1099-SA and 5498-SA, if you choose to accept mistaken distributions, do not report the distribution amount on Form 1099-SA or the recontributed amount on Form 5498-SA. If you did report the mistaken distribution, you should file a correction as soon as the error is discovered.

[Opus 17]

So firstly, you should call the HSA bank back and see if they will accept a “return of mistaken distribution”. Use that exact terminology.  If they accept the return, they will issue a corrected 1099-SA, and you will report the net amount as your withdrawal. You don’t need to wait for the corrected 1099 to file your tax return.

If they don’t accept a return, then since the reimbursement was paid to you in 2022, you don’t actually have a problem for 2021. Your expenses were legitimate at the time. Report on your 2021 tax return that you used all of the distribution for qualified expenses.

Then, if you have additional medical expenses in 2022, you can count the reimbursement as being used toward those expenses.  If you don’t have medical expenses in 2022, you would report the uncovered distribution as a “taxable recovery”. This is a technical term for a reimbursement of a previous tax deduction, and it is contained in the “other uncommon income” section of TurboTax.

For example, if you had $1000 of medical expenses in 2022, you would report $2900 as a taxable recovery.  This is income on your 2022 return, not 2021, because the reimbursement was paid to you in 2022.

2022 might be a good year to catch up on any minor medical expenses that you have been putting off, such as routine eye exams, new eyeglasses, or get your kids started on the braces that they will eventually need.

Additionally and completely unrelated to income tax, I would also contact whatever local news channel has a “news on your side“ segment.  I work adjacent to the hospital industry and I have never encountered a billing person coming into the patient’s room and demanding payment while the patient is there, under care, and in such a stressful situation. I have been asked to pay an estimated balance before a procedure when it was scheduled in advance, and I have been billed after a procedure, but I have never been approach for money in the middle of a hospitalization.  That seems unethical and coercive. And it seems like something that a news organization looking for story content might want to chase down. The hospital at least needs to be embarrassed over this.

[Opus 17]

@Mike9241 

Mike, the instructions you quote about not reporting the distribution are for the HSA bank, not the taxpayer.  If the HSA bank accepts the return of a mistaken contribution, they report the net distribution (after accounting for the return) on the 1099-SA.

If the reimbursement also occurred in 2021, the same year as the distribution, it creates an event subject income tax and penalties if it is not returned.  Here, since the distribution occurred in 2022, there are no taxes and penalties for 2021. If the bank does not accept the return, the taxpayer has until the end of 2022 to apply the money to other qualified medical expenses, or else report a taxable recovery.

[Diane_]

Thank you both very much for the great information and advice. Due to my daughter's ongoing medical issues, I have already paid more than $6K out of pocket for medical bills in the month of January 2022.

Therefore, is the simplest solution to just use the $5500 hospital payment receipt (in 2021) as the evidence of the full costs in 2021 (since that amount was legitimate at the time), if I am audited by the IRS?

Based on several previous conversations with HSA Bank, I do not think they will agree to issue me a corrected 1099-SA (but I can keep trying if that is the better way to go).

Since I will be applying the full $3900 reimbursement (received in 2022 directly back to HSA account) to qualified medical expenses incurred in 2022, I will not have to report a taxable recovery on 2022 taxes, if I understand correctly. Will there be anything special to do on the 2022 tax return then, or just ensure that my distributions for 2022 exceed $3900?

Another Question: Does that $3900 reimbursement now count as an official HSA contribution for 2022, even though the money was originally contributed in 2021 and is part of the 2021 5498-SA? I hope not, but thought I should ask, because if it is, I will need to reduce my payroll deductions for this year so that I don't over-contribute in 2022.

Thank you!

[Opus 17]

@Diane_ 

"Therefore, is the simplest solution to just use the $5500 hospital payment receipt (in 2021) as the evidence of the full costs in 2021 (since that amount was legitimate at the time), if I am audited by the IRS?"

This is acceptable under the circumstances.  However, since you now have a 2022 refund, you need to apply that to your 2022 medical expenses.  If you have paid $6000 so far, $3900 is covered by the refund (which represents tax-free HSA money) so only $2100 remains eligible for future reimbursement from your HSA or as a medical expense deduction. 

" (received in 2022 directly back to HSA account)"

This is new information to us.  By depositing the money in the HSA without going through the "return of excess distribution" procedure, it is a regular contribution.  Once money hits your checking account or wallet, it loses any uniqueness based on it's source and it's all just money.  You paid $6000 to the hospital so far and you contributed $3900 to the HSA.  You can't say "but that $3900 is not a contribution, its a return" because the bank refuses to process it as a return and you just made a contribution.  (In fact, if you made the deposit first, that's probably part of the reason why they are refusing to treat it as a return, because you had to set that up in advance.)

"Does that $3900 reimbursement now count as an official HSA contribution for 2022, even though the money was originally contributed in 2021"

If you deposited the money into the HSA and the bank did not accept it as a return, then it is a new contribution.  Remember, it's all just money.  You got a withdrawal, you made a deposit.  If you didn't or couldn't follow the rules for a return of excess distribution, then it's just a contribution and you may need to reduce your payroll contributions (or stop them early) so you don't exceed your limit for 2022.  

[Diane_]

Hello, thanks for the reply. Sorry but now I'm getting more confused. As I mentioned in my original post, the reimbursement went directly from the hospital back to the HSA Bank account without my advance knowledge.

All the contributions I've ever made to the HSA have come directly from payroll deductions. I paid the $5500 hospital bill in 2021 directly from the HSA with my HSA debit card (big mistake it turns out). The hospital refunded $3900 back to my HSA debit card in 2022 without my knowledge, so the money went right back into the HSA account and was never touched by me (but I saw online that it reappeared back in my HSA account.) There was no 'return of excess distribution' procedure for me to follow, as I did not know it happened until after the fact and was never in possession of the money outside the HSA Bank account.

Example:

1. $8000 in contributions to HSA in 2021 via payroll deductions only (no after-tax contributions directly from my regular bank account) .

2. $5500 payment to hospital in 2021 via HSA Bank debit card; money transferred directly from HSA Bank to hospital (HSA balance $8000-$5500 = $2500).

3. $1600 statement received from hospital, excess $3900 refunded from hospital directly to my HSA Bank debit card/account in 2022 (HSA $2500+$3900 = $6400).

4. That $3900 refunded directly from the hospital was money that I had already contributed in 2021 (part of the original $8000). So if it needs to be counted as a contribution again in 2022, then it will be included on the 5498-SA for 2021 and again on the 5498-SA for 2022, so reported twice but only contributed by me once.

6. That $3900 went directly from the hospital back to my HSA account so the only way I can use it for medical expenses is to make a claim against 2022 expenses and distribute it out of HSA Bank again. Then it will also appear as a distribution on the 2022 1099-SA, so will show as being distributed twice. 

7. The $6000 I've paid in medical bills so far in 2022 I have paid out of my private emergency fund, because until I figure out how to sort out this mess I don't want to use the HSA Bank account for anything. Eventually I hope to be able to make claims against the HSA Bank for qualified medical expenses I've already paid privately in 2022.

At this point, is the best course of action to abandon trying to do my 2021 taxes with TurboTax and hire a tax professional to file my taxes for me this year? I don't know how I can fix this and be in compliance with the IRS. Thanks.

[Opus 17]

@Diane_ 

Exactly how is the HSA Bank treating the debit card refund?  As a new contribution for 2022 or a return/refund of a prior distribution?  

• I could see them counting it against the 2021 distribution, so your 2021 1099-SA would read $1600 (although that's technically wrong, we can work with it)
• I could see them counting it as a returned distribution
• I could see them blocking the refund so the hospital would have to issue a check (but this clearly didn't happen here)
• I can't see a legal or logical way for them to treat it as a new 2022 contribution.

What's their explanation?  What's their excuse?

And if they are treating it as a new contribution, what's their reasoning for that?

[Opus 17]

@Diane_ 

My HSA Bank says they would treat it as a "refund" and revise the 1099-SA to reflect less of a distribution (if the spend happened in December and the refund in January).

[Diane_]

Thanks for the reply. Below is the info posted to one of my HSA Bank accounts (partially redacted). It looks like they added $3740 to my total gross distributions in 2021 and then deducted $3740 from my total gross distributions in 2022.

I called twice and asked them to change the credit in 2022 to apply it to tax year 2021 and they refused. I can call again and try to explain in a better way. I also found a "Health Savings Account (HSA) Tax Correction Form" on the HSA Bank website that I can submit to see if that would work? It has an option to identify the transaction date and amount and then I can choose "change to prior year" and "reimbursement from provider or insurance". Shall I try that next? 

ORIGINAL PAYMENT (2021):

11/18/2021	BANNER THUNDERBIRD MEDCTR	Debit Card		$3,740.00	Debit
Transaction Details Request Date: 11/18/2021 4:36:33 AM (CT) Effective Date: 11/18/2021 Amount: $3,740.00 Payment Details Amount: $3,740.00 Status: Paid 1099-SA Tax Details Tax Year: 2021 Description: Normal Earnings on Excess Contributions: $0.00 Gross Distribution: $3,740.00 Debit Card Details Card Number: XXXXXXXXXXXX Date of Service: 11/16/2021 Merchant: BANNER THUNDER

REIMBURSEMENT (2022): 

01/10/2022	BANNER THUNDERBIRD MEDCTR	Debit Card	$3,740.00	Credit
Transaction Details Request Date: 1/8/2022 4:55:13 AM (CT) Effective Date: 01/10/2022 Amount: $3,740.00 Payment Details Amount: $3,740.00 Status: Paid 1099-SA Tax Details Tax Year: 2022 Description: Normal Earnings on Excess Contributions: $0.00 Gross Distribution: ($3,740.00) Debit Card Details Card Number: XXXXXXXXXXXX Date of Service: 01/04/2022 Merchant: BANNER THUNDERBIRD MEDCTR

[BillM223]

As Opus has indicated, the correct procedure would be for your HSA custodian(s) to accept your request to consider the 3,900 (or 3,740 or whatever) to be a mistaken distribution. If they would accept your request, then you would have to come up with the 3,900 and pay them back - I imagine that this might be difficult in your current circumstances.

But please see this:

"

HSA Mistaken Distributions

If amounts were distributed during the year from an HSA because of a mistake of fact due to reasonable cause, the account beneficiary may repay the mistaken distribution no later than April 18 following the first year the account beneficiary knew or should have known the distribution was a mistake. For example, the account beneficiary reasonably, but mistakenly, believed that an expense was a qualified medical expense and was reimbursed for that expense from the HSA. The account beneficiary then repays the mistaken distribution to the HSA.

" 

See "HSA Mistaken Distributions" in the 1099-SA instructions.

Note that you have until April 18, 2022 to report a mistaken distribution, so like Opus, I do not understand what their excuse is for not considering your request.

However, just below that, the instructions add:

"As the trustee or custodian, you do not have to allow beneficiaries to return a mistaken distribution to the HSA. However, if you do allow the return of the mistaken distribution, you may rely on the account beneficiary's statement that the distribution was in fact a mistake."

So the HSA custodian(s) could dig in their heels and refuse to change the paper work and you literally can't do anything about, even though you were obviously not at fault. This is why I encourage taxpayers in your situation to grovel if they have to to get the HSA custodian to change their paperwork to show that the return of the 3,900 was a refund and not a contribution. After all, it's just some paperwork on their part, but it will be a big deal for you.

Be sure to point out the April 18, 2022 date, because they may think they can't accept a mistaken distribution request across the end of a calendar year, but they can.

On the 1099-SA that you have (will?) receive, I would just report that all of the distribution of 6,000 was spent on qualified medical expenses - this has the advantage of being true. The problem is that the HSA custodian has on their books that you had this 3,900 contribution in 2022 which you didn't make. 

For tax year 2022, your W-2 will report your HSA contributions, and when you make your entries into TurboTax, TurboTax is not going to be aware of that 3,900 (1099-SA distributions and HSA contributions don't affect one another). So, so long as you don't tell TurboTax about this 3,900 contribution in 2022, your 2022 return should be fine. 

The problem is that the paperwork at the HSA custodian will be out of whack with what actually happened and this difference will appear on the 5498-SA. Fortunately, you don't enter anything from the 5498-SA on your return.

But if you are ever audited, then if the auditor looks at your returns and the 5498-SAs and the custodians' records, then they will be inconsistent. At that point, I would hire an Enrolled Agent or CPA or maybe even a tax attorney (if you can get one for cheap) to represent you in the audit. And if you are never audited, then no harm done - you are not out any money and you did the right thing as best you could.

The IRS needs to address this relatively common issue of taxpayers getting refunds from doctors and hospitals which end up going straight back to the HSA and getting reported as a contribution.

@Opus 17

Does this sound good to you?

[Diane_]

Thank you for all the great information. I called back HSA Bank and they insisted to me over the phone that the amount refunded back directly to the HSAs by the hospital is NOT going to be reported as a contribution for 2022. They said they it is considered as a refund against the original payment from last year. 

In that case, if I understand correctly, I should report on my 2021 tax return the full $6000 distribution since that is what is on my 1099-SA. 

Then in 2022 I received the refund of $3900, which was recorded by HSA Bank as a "gross distribution" of negative $3900. So if for example I spend $5000 this year on qualified medical expenses (which I will), then on my 1099-SA for 2022, it will show $5000 - $3900 = $1100; is that how it works? Then the total distributions over a 2 year period will be correct.   

In this situation the 5498-SA for both 2021 and 2022 should match what is on my W2, assuming I don't make any contributions outside of payroll deductions.

Thoughts?  

Thank you!

[BillM223]

"the amount refunded back directly to the HSAs by the hospital is NOT going to be reported as a contribution for 2022."

Well, this is good.

"if I understand correctly, I should report on my 2021 tax return the full $6000 distribution since that is what is on my 1099-SA. "

Yes, it's always preferable to have your numbers correspond with the numbers on forms that the IRS gets copies of. Besides, if I got your story right, you did indeed spend the whole $6,000 on qualified medical expenses.

"Then in 2022 I received the refund of $3900, which was recorded by HSA Bank as a "gross distribution" of negative $3900. So if for example I spend $5000 this year on qualified medical expenses (which I will), then on my 1099-SA for 2022, it will show $5000 - $3900 = $1100; is that how it works?"

At this point, I don't know what they're doing - this is beyond what the IRS describes in Pub 969 or what the IRS has published in a variety of notices. In fact, for Box 1 on the 1099-SA, the IRS says explicitly for the HSA custodian: "Do not report a negative amount in box 1" which they would have to do if you spent less than $3,900 in the current year. I don't see where they're going with this, but never mind, because you are going to complete your tax return as accurately as you can, and if there's ever an audit, you will show them all the paperwork to explain why you did what you did.

"The 5498-SA for both 2021 and 2022 should match what is on my W2"

I wouldn't worry too much about matching numbers between the 5498-SA and the W-2s. For example, Box on the 5498-SA contains

(1) Enter the total HSA or Archer MSA contributions made in 2021,

(2) Include any contribution made in 2021 for 2020 (!),

(3) Also include qualified HSA funding distributions (trustee-to-trustee transfers from an IRA to an HSA under section 408(d) 9)) received by you during 2021, but

(4) Any excess employer contributions (and the earnings on them) withdrawn by the employer pursuant to Notice 2008-59, Q/A 24, available at IRS.gov/irb/ 2008-29_IRB#NOT-2008-59, should not be reported as a contribution.

So you can't quickly compare numbers from here to there; instead, you have to sit down with a spreadsheet, and see the totality of what has happened.

Really, the most important thing is the HSA custodian not report the refund as a contribution for 2022 - everything else is reasonably trivial. We were worried because we know that other HSA custodians have reported such refunds as contributions.