Mistaken HSA contribution while being ineligible

[redrooster99]

On January 1st 2025 I opened an HSA with Fidelity and made a contribution of $4300 for 2025 tax year, thinking I had a qualifying HDHP. Well, it turned out it is NOT a qualifying HDHP and therefore I was ineligible to contribute. The money is sitting in the HSA, I have not made any withdrawals. I have already had income tax withheld on the money I contributed (i.e have not made any deductions with the contributed money).

How should I proceed to avoid tax penalties?

I called Fidelity and they advised me to submit to them a "Return of Excess Contributions" form. I assume the whole contribution I made is considered excess. After this I would get a 1099-SA with "code 2" and a calculated profit/loss made on the contribution, and this should be filed with my 2025 taxes.

My understanding is that the returned $4300 excess contribution would avoid the 6% excise penalty, however it would be considered a "distribution", which would be subjected to income tax. However I already had income tax withheld on that money. So I would essentially be double taxed? Please help me understand.

[NCperson]

@redrooster99 it is not considered a taxable distribution - you are overthinking it.   You made a contribution and you are getting it back.  It's a big wash.  

the money that was withheld will be part of your 2025 tax return in a year - you'll get the money back.  Adjust your withholdings at work if you'd like so you get it back over the course of 2025.  

don't confuse 'tax' with "withholdings"... "tax" is ONLY calculated on a tax return and no where else. 

[Mike9241]

"I have already had income tax withheld on the money I contributed." I'm not sure what you mean because as a deduction you would need less taxes withheld. How was this done? Did you adjust your w-2 withholding to take this "deduction" into account? If so, you may need to adjust your withholding so you are not subject to the underpayment of estimated tax penalty when you file 2025.

[redrooster99]

Thank you, you made me realize what I've said is incorrect. That $4300 I contributed will still be included in my W-2. I got FICA tax and income tax confused (what a noob mistake!).