How to correctly report excess employer HSA contributions withdrawn

[antequ]

Hi,

In 2023, my employer and I contributed $4850 into my HSA plan through payroll deductions (subtracted from W2 box 1, reported in box 12 code W), and I withdrew $370 in 2023 of excess contribution (1099 SA code 2). The reason I did this is, I was on an individual HDHP for 10 months and family Nov - Dec; the last month rule would qualify us for $7750 in contributions (when the pro-rated limit should actually be $4520), however we are not getting a HDHP in 2024, and so we would like to avoid the penalty for the 12-month period when we file taxes next year.

I filled the TurboTax questionnaire correctly for my 1099-SA, however it is not adding this $370 to my income anywhere. Do I need to separately report the $370 somewhere? Either in other income or in form 8889? Or do I wait until next year to report the $370? (will it incur a penalty for the last-month rule violation?)

[antequ]

To clarify further, my employer left out the $4850 from box 1 income and reported it in Box 12 code W for the HSA contribution, indicating it is employer-contributed. But I withdrew $370 in excess (1099 SA with distribution code 2). How do I report the $370 of income?

[BillM223 · Accepted solution]

First, the code W amount in box 12 is called  the "employer contribution" but it actually refers to the amount that the employer PLUS the amount that the employer contributed through payroll deduction. Don't blame TurboTax, it's the IRS' terminology.

Second, TurboTax did not detect an excess HSA contribution because you didn't make one (yet). Therefore, TurboTax did not do the automatic processing to add the excess back to your income.

TurboTax automatically uses the last-month rule, and there is no way to stop that. So what will happen is that next year (assuming you use TurboTax again), TurboTax will notice that you used the last-month rule but did not maintain HDHP coverage. This will lead you into an interview that you haven't seen before which will calculate what your annual HSA contribution limit would have been without the last-month rule, and assess any action based on an excess.

And, yes, there will normally be some sort of amount due because people in this situation usually have excess contributions because the last-month rule gives a higher limit than what they actually merited.

As for the $370 distribution, that's a problem. May I assume that this $370 include the earnings on the "Excess"? Furthermore, since you actually did not have an excess in 2023, this is a distribution for reasons other than qualified medical expenses, which should not only be added to your income but also incur a 20% penalty.

That is, the IRS does not provide a way to withdraw an excess in advance.

The simplest thing to do is this:

1. Contact the HSA custodian and say that you want to return a Mistaken Distribution. This is how you will return the $370 to your HSA. Note that the form for doing this is often online at the custodian's website.

2. Next year, TurboTax will discover that you did not maintain HDHP coverage and will ask you a lot of questions about your 2023 contributions and income and whatnot. Then whatever you owe will be added to your tax due...and that's it.

No special calculations on your part or special manipulations of your HSA.

[dmertz]

As BillM223 indicated, it was improper for you to request a return of the $370 because it was not an excess contribution.  Only actual excess contributions are eligible to be returned and failing to complete the testing period for the last-month rule does not result in an excess contribution.  Because there was no excess contribution, TurboTax does not provide an opportunity to indicate that you had some amount of excess contribution returned.

Because no return of excess contribution was permitted under these circumstances, the distribution of the $370 constitutes a regular distribution and must be treated as such.  For failing to complete the testing period, on your 2024 tax return you'll still owe income tax and the 10% penalty on the amount that you would have been an excess contribution were it not for the last-month rule.

[antequ]

Thanks for the response!

There were no earnings on the excess --- the earnings field was 0 in both 1099-SAs. I should clarify that I received two 1099-SAs, one for the qualified medical expenses that I withdrew for the year, and another for the $370 excess contribution withdrawal.

I just faxed a mistaken distribution form to ask my HSA custodian to return the mistaken distribution of $370, for tax year 2023. I assume they will update the 1099-SAs with the IRS. Is there a way they can indicate that the $370 was to undo the $370 excess withdrawal, and not to be subtracted from the other 1099-SA? Does this matter which 1099-SA they update?

[dmertz]

If they accept a return of mistaken distribution, they should correct the $370 Form 1099-SA to show $0 instead.