HSA overfunded in 2020

[daletoo63]

I filed my taxes and got my refund, but the amount the IRS deposited was $121 less than the refund showing in Turbo Tax. I tracked it down to a $560 deduction that Turbo gave me for a 2020 overfunding of my HSA in that amount. I followed the walk-thru and answered all the questions, and that's how TT did it. Here are the details:

1. I over-funded my HSA by $560 in 2020. I didn't realize I had done so until I filed my taxes (March 2021, also using TurboTax).
2. I did NOT withdraw the over-funded amount at all, and I paid the 6% tax/penalty in 2020.
3. On my 2021 taxes, Turbo Tax took the amount from form 5329/line 48 (the $560) as an HSA overfunding, and taxes were calculated based on that. It did NOT ask any questions about whether I had withdrawn that money or not - it just took it from last year's return. I believe the $560 ended up as a deduction. I answered Yes to the overfunding question, since I had an amount on the 2020 from 5329, line 48.
4. The IRS removed the $560 deduction, which reduced my refund by $121.  Why? While I did not withdraw the $560, I UNDER-funded my HSA for 2021 by $1,160.08 (maximum is $3,550, I only contributed $2,389.92) - shouldn't the $560 overage from the prior year just roll over as a contribution for 2021 since I was well under for 2021?  And thus have been a deduction? Why does the IRS not think so?

I'm not sure if I need to do something else to fix this, and I think the IRS should not have adjusted my refund.

[BillM223]

1. You had Self-only HDHP coverage, right? For how many and which months?

2. Were the HSA contributions in 2020 and 2021 made directly to the HSA custodian, or were they made through your employer (or both)?

3. "The IRS removed the $560 deduction" - Did you get a letter from the IRS? What exactly did the letter say?

4."On my 2021 taxes, Turbo Tax took the amount from form 5329/line 48 (the $560) as an HSA overfunding,". TurboTax almost certainly took the $560 from the Carryover Worksheet instead, but the effect is the same.

5."The IRS removed the $560 deduction, which reduced my refund by $121.  Why? While I did not withdraw the $560, I UNDER-funded my HSA for 2021 by $1,160.08 (maximum is $3,550, I only contributed $2,389.92) - shouldn't the $560 overage from the prior year just roll over as a contribution for 2021 since I was well under for 2021?  And thus have been a deduction? Why does the IRS not think so?" - Yes, that $560 should have appeared on your 8889 line 13 and on line 13, Schedule 1 (1040). I don't know why the IRS would have removed it. Perhaps your other answers will tell me they did and why.

[daletoo63]

1. Yes, I was covered by a self-only HDHP for the entire year, both in 2020 and 2021

2. Both. I have regular contributions through my employer, but I made a couple of additional direct ones to cover some expenses.

3. The IRS supposedly has SENT the letter, but I haven't received it yet. The amount of my refund that was deposited was $121 less than I was expecting, and I was able to come up with that amount by removing the $560 deduction.

This has turned into quite the mess for me - LOL. While looking through things, I discovered I actually made a mistake in 2020.  I entered too much for my direct/additional contributions (I inadvertently included the 2019 additional contributions).  I entered $3,150 of addition contributions on my 2020 return, when it was really only $1,750, which is what led to the $560 over-funding. So now I have to do an amended 2020 return. That removed the $31 excise tax on the overage, but now I owe more taxes because of less deductions. The IRS has already "amended" the 2021 return for me, and the reduction in refund of $121 is correct. I also have to file amended returns for Michigan for 2020 and 2021, as there is a little more tax owed there as well. Such fun!

[BillM223]

"The IRS has already "amended" the 2021 return for me, and the reduction in refund of $121 is correct"

Yeah, but this won't be correct until you amend your 2020 return, which you haven't done yet. So I have to wonder what the IRS did and why, just in case they did something different all together that happened to have similar impact on your tax.

"Both. I have regular contributions through my employer, but I made a couple of additional direct ones to cover some expenses."

The reason I asked this is because how TurboTax handles the excess contribution in 2020 depended on whether it was a direct contribution or a contribution through your employer.

HSA contributions through your employer appear on your W-2 in box 12 with a code of W. Most taxpayers don't realize that this code W amount is removed from Wage in boxes 1, 3, and 5 before the W-2 is printed. This means that the excess contribution doesn't originally appear in income.

But an excess contribution can't be excluded from income, so any amount of the excess that went through your W-2 has to be added back to Other Income on line 8 of Schedule 1 (1040).

Your direct contribution is different. Since it is a deduction (line 13 on Sch 1 (1040) for 2021 - it was on line 12 in 2020) - if there were excess contributions that you made from direct HSA contributions, then the number that would have been on line 13 just gets reduced - no manipulation of income is necessary.

If you would, let us know what the IRS has to say...

[daletoo63]

I received the IRS letter, and all it said was that there was an error made on form 8889, which affected the amount carried to the Schedule A itemized deductions.  Nothing about previous years or anything. I still don't understand why they think it was an error, since I UNDER-funded the HSA (by a lot) in 2021, and everything I've read says it should just carry over (which Turbo Tax did) as a contribution to the next year. But, since it ended up the correct amount because of the error in 2020, I'll leave it.

[BillM223]

I think we're talking about two different issues here.

The first is that the IRS removed $560 in deductions (so you believe). Are you able to Itemize, that is, is there a Schedule A on your 2021 return? It may be that the IRS removed the $560 that was carried over from your Schedule A.

Is the $560 part of the Medical and Dental expenses on your Schedule A? 

Was that $560 a contribution made through your employer or made by you directly to your HSA custodian?

Did they tell you what the error was on the 8889? And for which year?

[daletoo63]

The exact letter says:

We found an error on your 2021 Form 1040, which affects the following area of your return: Adjustments to Income. We changed your return to correct this error.

and

We changed the amount of health savings account deduction on your tax return because there was an error on your Form 8889, Health Savings Accounts (HSAs). The error was in one of the following:

- Computation of the health savings account deduction on Form 8889.

- Transfer of the amount to your tax return.

The $560 overage in question was from direct contributions that I made in 2020 (after tax), NOT through my employer. 

My 2020 Form 5329 has the following data:

Line 47: $560 (excess contribution)

Line 48: $560 (total excess contribution)

Line 49: $31 (Additional tax)

My 2020 Form 8889 has the following data:

Line 2: $3,150

Line 3: $4,550

Line 4: $0

Line 5: $4,550

Line 6: $4,550

Line 7: $0

Line 8: $4,550

Line 9: $1,960

Line 11: $1,960

Line 12: $2,590

Line 13: $2,590 (carried forward to Form 1040, Line 10a)

My 2021 Form 5329 has the following data:

Line 42: $560

Line 43: $2,210

Line 44: $0

Line 45: $2,210

Line 46: $0

Line 47: $0

Line 48: $0

Line 49: $0

My 2021 Form 8889 has the following:

Line 2: 0

Line 3: $4,600

Line 4: $0

Line 5: $4,600

Line 6: $4,600

Line 7: $0

Line 8: $4,600

Line 9: $2,390

Line 11: $2,390

Line 12: $2,210

Line 13: $560 (appears on Schedule 1, Line 13 and on Form 1040, Line 10)

TurboTax did ALL of this - all I did was answer the questions, and it transferred the info from my 2020 return, which I also did with TurboTax.

[BillM223]

So there is a "ghost" $560 on line 2 of the 2021 8889? Thus when TurboTax for line 13 chose the smaller of line 2 or 12, since line 12 was $2,210, line 2 must have invisibly been $560 for line 13 to become $560, right?

OK, this can happen if you had a carry over of excess contributions of $560 from 2020. The way it's supposed to work is that the annual HSA contribution limit should be reduced by the carry over, but the 8889 doesn't have a way to show this, so TurboTax puts the invisible carry over on line 2 as if it's a personal contribution...which the 8889 can't show either. 

Unfortunately, the IRS didn't catch this. Fortunately for you, form 5329 is correct, so that the 2020 carry over of $560 was correctly used up in 2021.

Did the IRS in the letter invite you to reply to them to show evidence that your return is correct? (They usually do). In this case, please make a new 8889 (handwritten will be fine) in which you enter $560 on line 2, so that your 8889 now makes sense (i.e., line 13 really is the lessor of line 2 or line 12. Also, make a copy of your original schedule 1 and 1040. Also add a copy of your 2020 5329, showing the $560 was an excess in 2020.

Next, write an explanation of why line 2 should be $560. Explain that it is a carry over of an excess contribution from 2020 (see form 5329, attached), but that the software does not print line 2 on the 2021 8889 in this case. But this is why line 13 was $560, because the software should have put the carry over $560 on line 2 but didn't.

With luck, the IRS will recognize what happened and accept your explanation so that you will not have to pay the extra tax.