"we should just note that we are withdrawing the $125 overage from this year, despite TurboTax stating we had an excess contribution of $2,750, correct?" - No, let's don't do this (your 8889 will be wrong if nothing else); instead let's do it right.
Please read the following, which solves the common causes of excess HSA contributions.
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It is possible to accidentally indicate to TurboTax that you made excess HSA contributions when perhaps you haven't.
I understand that the following list is long, but these are all reasons that taxpayers get excess contribution messages.
If you find that your situation is not one of these cases, then please make a new post in which you indicate:
- your HDHP coverage and for how many months
- your spouse's HDHP coverage and for how many months
- your HSA contributions (both through your employer and directly to the HSA)
- your spouse's HSA contributions (both through your spouse's employer and directly to the HSA)
- the amount of the excess
- whether or not either of you went on Medicare and what month
- whether or not (and the amount) of carryover of excess contributions from 2018 for either of you
***main answer***
One of the purposes of the HSA interview is to determine your annual HSA contribution limit.
As you probably know, the maximum limits in 2021 are:
- $3,600 - individual with self-coverage
- $7,200 - individual with family coverage
- If the HSA owner is 55 or older, then you add $1,000 to these amounts.
However, these limits assume that you were in an HSA all year. If you left the HSA during the year or started Medicare or had one of a number of change events, then the limit is reduced.
There are several major culprits for excess contributions (other than just actually contributing more than the limit).
First, if you did not complete the HSA interview - that is, go all the way until you are returned to the "Your Tax Breaks" page - the limit still might be set to zero, causes a misleading excess contribution message.
There are questions all the way to the end of the interview that affect the annual contribution limit.
Second, it is not unusual for taxpayers to accidentally duplicate their contributions by mistakenly entering what they perceive to be "their" contributions into the second line on the "Let's enter your HSA contributions" screen.
Normally, any employee who made contributions to his/her HSA through a payroll deduction plan has the contributions included in the amount with code "W" in box 12 on the W-2. This is on the first line on this screen. Don't enter the code W amount anywhere on the return other than on the W-2 page.
Third, if you weren't in HDHP coverage all 12 months, then the annual contribution limit is reduced on a per month ratio. NOTE, this means that you have to indicate when and under what type of HDHP plan you had. Be sure to answer the questions on the screen entitled "Was [name] covered by a High Deductible Health Plan in 2021?".
Fourth, if you had a carryover of excess contributions from 2020, then this carryover is applied to 2021 as a reduction to the 2021 HSA contribution limit, which could cause an excess condition in 2021 as well. But note: if you had an excess contribution in 2020 but cured it by withdrawing the excess in early 2021, then do NOT report an "overfunding" on your 2021 return.
Fifth, the Family limit ($7,200) is for the aggregate of contributions by both taxpayers, even if both taxpayers have their own HSAs. That is, one taxpayer can’t contribute $7,200 to his/her HSA and the other contribute $3,600 to the other HSA – the $7,200 limit applies to the aggregate of all HSA contributions credited to the family (in this case, the excess contributions would be $3,600).
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