@Steelydan989 wrote:
Thank you, I appreciate all your time working on helping me. What you've said is very helpful in understanding how this all works. A few questions re what you said above:
I'm ineligible to have an HSA. I'm a dependent on someone else's tax return and can't have an HSA until I'm independent (a few years away). How could I use this money now for medical expenses as I'm ineligible for an HSA?
Re issuing an amended 2019 return: Would I report excess contributions to an HSA even though I'm a dependent and don't have an HSA? Is there a 6% penalty to mistakenly open an HSA account, contribute to it and pay tax on that money? It seems strange there would be these penalties for a mistake where I've had no financial benefit and the IRS has lost nothing from my mistake.
If I do keep the distribution now, would I have to pay taxes a second time on that same money along with the 20% penalty?
You aren't ineligible to own an HSA, you are ineligible to contribute. That's an important distinction. I am currently ineligible to contribute, because I changed employers and insurance, but I own an HSA that I contributed to in the past, and I can continue to use that money to pay for out of pocket medical costs even though I am ineligible to make new contributions.
Once you have money inside an HSA, even if it was contributed through an improper transaction, that HSA is covered by all the usual rules on withdrawal. That means that withdrawals are subject to income tax and a 20% penalty unless used for qualifying medical expenses, even though the contribution was already taxed.
You must report the contribution on your 2019 return. You made a non-permitted transaction and did not correct it properly, there is a penalty for that. You can't simply ignore it. The penalty was created by Congress to discourage people from making non-permitted transactions. One of the reasons is that HSA money can be invested in stocks or mutual funds that might provide much more than 6% growth--if there was no penalty for improper contributions, there would be a strong incentive to make improper contributions, get the tax-free investment growth, and pay expenses tax-free from the tax-free investment growth. So the financial penalty is that you pay the tax plus a 6% penalty, and that 6% penalty reoccurs every year as long as the improper contributions remain in the account. (You might just as well ask why there is a fine for getting a speeding ticket if no one was hurt--it's to discourage people from ignoring the rules.)
Once there is money in the account, even if it was improperly contributed, you must follow the rules on withdrawals. If not used for qualified medical expenses, the withdrawal is subject to income tax plus a 20% penalty, even if it was already taxed.
If you keep the money, it's subject to income tax plus a 20% penalty. If you return it to the account as a return of mistaken distribution, then it will be subject to a 6% penalty (which you may have to apply manually since the improper contribution was not recorded on your original 2019 return so it won't automatically carry over). the 6% penalty will reoccur every year until you are able to withdraw the money for medical expenses.
If you have medical expenses that your parents are paying for out of pocket, you can apply your withdrawals to those expenses. If your parents are paying for medical expenses and then getting reimbursed from their own HSA, you could coordinate with them to get the expenses reimbursed from your HSA instead of theirs, so to be able to drain your account without a penalty.
