HSA Excise Tax across multiple years

[falalala]

Hello!

My spouse is enrolled in an HDHP plan through her work and another plan that makes us (MFJ) ineligible to contribute to HSA in 2022 and 2023.

However, the employer is unable to stop automatic contributions to an HSA. So we end up paying taxes (Schedule 1) and an excise tax (Schedule 2).

In 2022, we received $200 in employer contributions and paid the taxes mentioned above.

In 2023, we received $1,000 in employer contributions. We also withdrew $250 from the HSA for qualified medical expenses. Therefore, the HSA had a balance of $950 at the end of the year 2023.

For 2023, $1,000 will go to Schedule 1 (no issues). The question is on the excise tax. Does it apply to $1200 ($1000 from 2023 plus $200 from 2022) or does it apply to the ending balance of the HSA in 2023 (i.e., $950)?

Thank you!

[BillM223 · Accepted solution]

In your case, the excise tax is based on the $950.

The "excise tax" (this is the correct term, but most people call it the penalty on the carryover of excess HSA contributions) is 6% of the smaller of the carryover amount or the value of your HSA on December 31 (for the 2023 tax return, December 31, 2023).

Before you file your return, please review your 8889 and 5329, because the excess HSA contribution is being doubled on some returns. Please see this article.

[falalala]

Thank you! To clarify, it doesn't matter that the funds were distributed, not withdrawn, correct?

[BillM223]

To fix an excess HSA contribution, you must notify the HSA custodian that you want to "withdraw" an excess contribution. The custodian will have you complete a form, and they will send you a check for the amount.

You cannot fix an excess contribution by distributing the amount, except in the following case. 

You must "withdraw" an excess contribution by April 15th (or whatever the due date is) to avoid any excise tax. If you miss that date, then a "distribution" will not fix the problem unless you make a distribution NOT for qualified medical expenses. In this case, the distribution will be added to your taxable income AND you will be penalized an additional 20%.

This is because the "excess" has nothing to do with how much you have in the HSA, but with how much you contributed in a given year. 

In rereading your post, I have to say that if you have not gone on Medicare, then this excise tax will continue year after year until you make distributions for non-qualified medical expenses, in order to wipe out the excess. Reducing the HSA balance to zero WILL zero out the penalty, but if you ever go back on an HDHP plan, then the excess contribution that has been carried over will just start the excise tax up again. Reducing your HSA balance to zero only sets the current year penalty to zero - it does not "fix" the carryover, which will just keep carrying over.

[falalala]

Thanks for the detailed response. I am still decades away from Medicare.

I think the other way around not having non-qualified distributions this is to count it toward the year's HSA limit.

In my case, if I start being eligible to contribute to the HSA, say in June, I can contribute the total allowed amount less the $1200 from previous years to avoid paying the excise tax. Right?

[BillM223]

Yes, if you have a carryover of excess contributions for one year, you can "use up" that excess in the subsequent year by contributing less than the annual HSA contribution limit in the subsequent year, so that the excess is used up.

For example, if you have a carryover of $1,000 from 2022 to 2023, and the limit for 2023 is $3,850, then you can contribute up to $2,850 in 2023, and the other $1,000 will count as a "personal" contribution in 2023. This will stop the carryover.

[falalala]

Thank you for the details and for your help in improving my understanding of the excise tax for HSAs.