HSA excess contribution situation (slightly complicated)

[sjlee0]

For 2023, we had two HSA family plans: one for me (over 55) and another for my wife (under 55). I had an HSA plan that covered our family for 1/1/2023 - 11/24/2023. I made HSA contributions of $8,471 (including employer contribution). My plan was terminated due to a job change, and my wife enrolled in an HSA plan (for family) for 11/1/2023 - 12/31/2023. During those 2 months, she received $400 as the employer's contribution. She herself did not make any contribution.

Now that we're looking into taxes, we realize we may have exceeded the HSA contribution limit. My understanding is that our total contribution limit is $7,750 + $1,000 (my catch-up). If we add up our contributions, it comes out to be $8,871. Our conclusion is that we have an excess contribution of $121.

We want to do the HSA excess contribution removal with my wife's HSA custodian (HSA Bank) before 4/15/2024 to keep things simple and not incur the excise tax. We're following up with HSA Bank on this. Two questions on this:
(1) Who does the excess money go to? Since it was all employer contribution in my wife's case, I presume that the money will go to the employer and not to us. I suppose we need to instruct HSA Bank specifically to do that?

(2) If the above is true, then do we still declare $121 as ordinary income in the 2023 tax return? Once the removal is complete, essentially it's as if we've never seen that money, correct?

TIA.

[Opus 17]

First, let's check the calculations.  If you were covered by plan for all 12 months, your family limit is $7750 plus a personal catch-up of $1000.  Because your spouse was "covered" by a family plan for all 12 months (even though she was not the "owner") her limit is $7750.  But your overall family limit is also $7750.

So you are $121 over.

Either one of you could do a withdrawal of excess contribution, it doesn't have to be from the spouse's account.  

If you withdraw amounts that were originally contributed by the employer, they still come to you.  They don't go back to the employer.  There is an IRS ruling on this that I can't find, but I'm pretty sure employer's can't take back the money in most cases, even if they wanted to, and there is no way in your wife's situation that they would even find out.

Turbotax should detect the excess and add it to your taxable income for you.  If you had made after-tax contributions to your HSA (in addition to the employer contributions) and you chose to remove those contributions instead, it would reduce your tax deductible contribution (which would have the same effect as adding the spouse's excess to their taxable income.)

[sjlee0]

Thanks for your reply! I haven't thought of withdrawing from my contributions. We'll consider that (if that makes things easier). Just to make sure, you're confirming that the excess amount is $121, right?

[dmertz · Accepted solution]

To avoid a penalty and double taxation, the distribution must be made as an explicit return of excess contribution, not a regular distribution.  The amount distributed must be the $121 excess adjusted for investment gain or loss.

When you tell TurboTax that your wife will remove the excess $121 contribution, TurboTax will include the $121 in your 2023 income since it was excluded from box 1 of you wife's W-2.  If there is any investment gain that is distributed along with the returned contribution, that will be taxable income on your 2024 tax return.