HSA Excess Contribution from 2020 Question

[hl438]

Need help with what I need to do

My situation:

1.  My wife and I had $2,000 in excess contribution of HSA in 2020 tax return - It was our first time using HSA and we messed up, and we didn't get chance to remove this.   

2. It got carried over to 2021 tax return - We submitted request to withdrew in April 2022.
We thought the request won't get process before tax deadline, so we went ahead to file the 2021 tax return. 
Later we got  excess distribution processed before the tax deadline 04/18,

We got 1099-SA marked for tax year: 2022 with distribution code 2

Questions:

1. If the 1099-SA marked for "tax year: 2022", does that mean we have to apply this for 2022 tax return?
    Or we should amend 2021 tax return?

2. Since distribution is pre tax money and we must pay tax (20% penalty) for this distribution.
     Where and how do I enter this this in turbo tax?
     I tried 2022 tax return and I tried to amend my 2021 tax return, but every time I go through the HSA portion, there is no place to enter this in turbo tax.

3. Any other tips/help how to deal with this?

[DanaB27]

1) Yes, you will enter the 2022 Form 1099-SA on your 2022 tax return.

2) The 2022 Form 1099-SA should have code 1 in box 3 since you removed the excess after the extended due date of the 2020 tax return. When you enter it on your 2022 tax return and indicate it wasn't used for medical expenses then TurboTax will automatically calculate the 20% penalty on your tax return.

1. Click "Federal Taxes" on the top and select "Wages & Income"
2. Click "I'll choose what to work on"
3. Scroll down and click "Start" next to "1099-SA, HSA, MSA" 
4. Answer "Yes" to "Did you use your HSA to pay for anything in 2022?"
5. Enter your Form 1099-SA information
6. On the "Did you spend your HSA money on medical expenses only?" screen select "No"

[hl438]

Thank you Dana.l!

So looks like first order of business for us to contact our HSA admin and correct this 1099

[hl438]

@DanaB27 

Is there an official IRS post or something somewhere that state whether it should be 1 or 2?

We contacted our HSA admin, and they asked back if we are sure if this is supposed to be code 1.

I did test on TTax that if I put code 2, it didn't increase the tax I owe. 

If I put code 1, it went up - which is correct.
Assuming it is code 1, does this mean TTax will remove this excess contribution and won't flag this when I do my 2023 tax return? 

==========================================================

From IRS https://www.irs.gov/pub/irs-pdf/i1099sa.pdf.

1—Normal distributions
Use this code for normal distributions to the account
holder and any direct payments to a medical service
provider. Use this code if no other code applies. Also, see
Distribution after year of death, earlier.

2—Excess contributions Use this code for distributions of excess HSA or Archer
MSA contributions to the account holder

[DMarkM1]

Code 1 is correct to make the distribution taxable.  In the follow on questions you should be asked if an earlier year HSA was over funded.  You would answer yes and put in the excess amount from the prior year.  As long as the taxable distribution covers that excess amount then nothing will be carried forward to 2023. 

[hl438]

Hi, we contacted the HSA admin and still got the same response back that they did the correct thing and couldn't change the distribution code.  What should we do next?

I read somewhere about providing explanation to IRS that it should be 2 instead of 1.

If we do efile with turbo tax, how do we enter this info? Or we have to submit through mail?

[xiao2001]

I have the same problem here.  My HSA admin refused to make change and asked me to check with tax advisor instead.

If I enter code 1 when entering in turbo tax, do I just provide explanation to IRS why I selected 1 over 2?
How do I attach letter of explanation if I do efile?
Can I do efile or I have to mail this manually? 

[dmertz]

@xiao2001 , As I understand it, you made an excess contribution for 2020 and did not obtain a return of contribution by the deadline, including extensions, for filing your 2020 tax return.  This means that you are not permitted to make a code-2 distribution to resolve the excess.  The only permissible way to resolve the excess by making a distribution is by obtaining a regular distribution (code 1, which it appears that you have done) equal to the amount of the excess (or more) and making the excess amount distributed taxable by not applying it to medical expenses.  The result is that it will be added to your taxable income (double taxation since this amount was not permitted to be excluded from your taxable income on your 2020 tax return) and, if you are under age 65, a 20% penalty will also be added to your overall tax liability.

No explanation to the IRS is needed.  After entering the code 1 2022 Form 1099-SA the you received and indicating that the amount applied to medical expenses was the gross amount minus the amount of the excess (possibly $0 applied to medical expenses), TurboTax will include the amount on 2022 Form 8889 line 16 (possibly subject to penalty on line 17) and on 2022 Form 5929 line 44, eliminating the excess.  None of this prevents e-filing.

[xiao2001]

Hi @dmertz  thank you for your response.  

The problem is the 1099 I received has code 2 instead of code 1.

Are you saying it is Ok enter code 1 while filing tax return (regardless of the code specified in 1099)?

---

No explanation to the IRS is needed.  After entering the code 1 2022 Form 1099-SA the you received and indicating that the amount applied to medical expenses was the gross amount minus the amount of the excess (possibly $0 applied to medical expenses), TurboTax will include the amount on 2022 Form 8889 line 16 (possibly subject to penalty on line 17) and on 2022 Form 5929 line 44, eliminating the excess.  None of this prevents e-filing.

---

[dmertz]

I didn't realize that your situation was identical in this respect to that of hl438.  If you made an HSA contribution for 2021 or 2022 it seems that the HSA custodian thought that you were correcting an excess contribution for one of those years.  If you made no HSA contribution for 2021 or 2022, the HSA custodian should have rejected what it thought was any attempt to obtain in 2022 any return of contribution that would be reportable with code 2.  It seems that it is not unusual for HSA custodians to not any responsibility for making this sort of error.

Unfortunately, for dealing with erroneous Forms 1099-SA the IRS provides no form similar to the Form 4852 that would be used to provide the correct information and explanation.  to get the numbers to appear on Forms 8889 and 5329 as I described you would have to enter this into TurboTax as a code-1 Form 1099-R, then provide an explanation statement, otherwise the IRS might mistakenly think that you over-reported your tax liability.  I don't think that there is any way to include such a statement in an e-filed tax return using TurboTax, so I think the statement needs to be prepared outside of TurboTax and included with your mailed tax return.  The code-1 Form 1099-SA that you enter should have the same gross amount in box 1 but nothing in box 2; box 2 only has meaning on a code-2 Form 1099-SA.  Hopefully the gross amount distributed was not less than the amount of the excess contribution, otherwise some excess remains in the HSA.  If more than the amount of the excess was distributed, you could potentially apply that to qualified medical expenses to avoid the tax and penalty on that portion.

Because both HSA custodians and IRA custodians are often inept at making the correct type of distribution to remove an excess after the due date of the tax return, it's best to tell the IRA custodian nothing about the distribution being to correct an excess and just ask for a regular distribution, but it's too late for that in this case.  I only mention this so that it might help someone else avoid getting the wrong type of distribution.

[xiao2001]

Thank you @dmertz .   

When I requested our HSA admin, I did state that it was excess contribution in 2020, and this amount I requested was more that what I contributed in 2022.  

I called HSA admin and they said it was excess contribution and regardless which year, they will only use code 2.    I also asked company payroll if any w2 need to be corrected (let say for 2022 tax year), and the response I got this is between me and our HSA, nothing to do with payroll.

I guess I have to just write explanation to IRS and hopefully that clears this

[dmertz]

It's problems like this from HSA custodians that are the reason that when obtaining from an HSA a distribution of an excess contribution after the due date of the corresponding tax return it is important not to tell the HSA custodian that the distribution is anything other than a reimbursement for medical expenses.  Telling them that the distribution is to correct such an excess leaves the door wide open for the HSA custodian to make a reporting mistake as happened here.

[xiao2001]

Thank you !  Another question, when I review 'all official forms required for filling', none of this distribution code 1 vs 2 are being mentioned.   I confirmed that I have to pay 20% penalty of this amount.

I understand IRS receives 1099-SA directly from our HSA admin, but since distribution code is not being stated anywhere in the tax return, does it matter if I actually provide letter of explanation to IRS or not?   

[dmertz]

On a Form 1099-SA, code 2 means that only the amount in box 2 is taxable and is not subject to the 20% penalty.  Code 1 means that any portion of the amount in box 1 that is not claimed as a qualified medical  on Form 8889 is taxable and, if you are under age 65 is subject to the 20% penalty.  The IRS Automated Underreporter System compares your tax return with what it calculates from the informational returns provided by payers and flags discrepancies, so if you don't provide explanation the IRS might modify your tax return to agree with the code-2 Form 1099-SA.

If you like, you could try filing without explanation and deal with the consequences later if the IRS changes your tax return, but that's up to you.