I contributed to an HSA for years while wife had HRA. How to make this right?

[dmertz]

IRS guidance invoking section 1.408-11 of the tax code means that that a code-2 distribution for a return of the 2022 excess contribution needs to include the attributable loss.  In other words, the return of the $3,600 contribution will be accomplished by a code-2 distribution of $3,524.50.  (The assumption here is that you either filed your 2022 tax return by the April 18, 2023 due date or you requested a filing extension by that date, otherwise it's too late to request a return of contribution before the due date of your 2022 tax return.)

"But the main question is, if they combine the 2022 and 2023 distributions on a single form, should box 2 still show the $125.60 gain (from 2023)? Or should it show combined net gain/loss for both years, which would show a gain of $50.10? Box 1 would show the same value of $5450.10 either way."

That's a question that has come up on this forum before.  If I remember right, the last time I saw a post about this situation the Form 1099-SA showed just the gain in box 2, not reduced by the loss.  ($125.60 in your case.)  This makes sense if the return of the 2022 contribution was the only contribution being returned, the loss could not be used to reduce taxable income.  The Form 1099-SA reporting the combined distributions simply sums the amounts in the respective boxes that the Forms 1099-SA would have had if not combined on a single form.

[MrHarriet]

This is my interpretation as well. If I took all $3,600 out for 2022, then it seems the IRS would consider the difference of ~$75 as a normal distribution, above and beyond what should have been removed as excess, and subject it to the additional penalty

Your explanation for the 1099-SA is what I thought as well. From what I read, tax software wants to count Line 2 as Other Income, so it would be inconsistent to report the ~$126 as Other Income for 2023 but only have ~$51 shown as earnings. So I told the HSA custodian to use ~$126 for the earnings in Box 2, and the ~$3525 as the distribution for 2022

[MrHarriet]

I told my HSA custodian that this (above) is how I plan to proceed, @dmertz. However, their response to me this afternoon suggests they have a totally different plan for addressing this. Here is what they said they're planning to do:

For 2021, they would complete a form 1099-SA with distribution code "2" and $475.01 reported as sent back as a distribution.

For 2022, they would amend the 2022 5498-SA. They would process the correction as an "Excess Contribution Reversal" which will remove it from reporting on the 5498-SA, in their words. This is where they must've been confused as to why I would request less than $3,600 to be removed, as they are planning to amend the 5498-SA rather than leave it alone and file a 1099-SA.

For 2023, they would remove the full year's contribution of $1,800 as an "Excess Contribution Reversal" as well, and remove it from being reported entirely. The gains of ~$126 would be sent back and reported on the 2023 1099-SA in box 2.

Does this sound right to you? Or do I need to request they file things differently? This is a fairly reputable HSA custodian, so if this is incorrect, that means that they're processing many of these incorrectly for people. @Opus 17, do you want to weigh in on this as well?

[dmertz]

This HSA custodian (or at least the representative you are dealing with) is clearly incompetent.  They need to read and understand the instructions for Form 1099-SA and 5498-SA.  They also need to read and understand IRS Notices 2004-50 and 2008-59 where these discuss excess HSA contributions.

The instructions for box 2 of Form 1099-SA indicate that this box is only for reporting the amount of earnings on a contribution returned before the due date of the tax return.  That's impossible for the $475.01 contribution made for 2021 because that deadline has passed more than 9 months ago.  As I've stated previously, the Form 1099-SA reporting the distribution of the $475.01 must have $475.01 in box 1, nothing in box 2 and code 1 in box 3.  You should just request a regular distribution to you of $475.01 and say nothing about it having anything to do with an excess contribution.  You treat it as resolving the excess contribution for 2021 by how you will report it on your 2023 Forms 8889 and 5329 as a regular taxable distribution.

They should not be changing any Forms 5498-SA.  Doing so would create a disagreement between amounts reported on the Forms 5498 and the amounts shown with code W in box 12 of your Forms W-2.  The only reason that a Form 5498-SA would be changed with regard to an excess contribution is if the HSA contributions deposited by your employer exceeded the annual statutory limit and the employer requested that the excess be returned to them (along with a corresponding change to your W-2), neither of which happened in this case.

I have no changes to what I have stated needs to be on the Forms 1099-SA.

[MrHarriet]

For the 2021 distribution, they aren't saying they would include anything in Box 2, @dmertz. They are saying they would include the total of $475.01 in box 1, and then use distribution code "2 - Excess Contributions" for Box 3.

Is there anything inherently wrong with this? I am not sure why they couldn't use code 2 - Excess Contributions since that is exactly why I am removing it. I can't find anything that indicates this code can only be used if it's by that year's tax deadline. All I can find on Box 3 is that code 2 - Excess Contributions should be used for "distributions of excess HSA or Archer MSA contributions to the account holder." Wouldn't this be the most accurate way to report the 2021 distribution?

[MrHarriet]

@dmertz, perhaps you can disregard my previous message. I found a similar question answered here: https://ttlc.intuit.com/community/taxes/discussion/how-to-enter-1099-sa-correctly-in-turbotax/00/288...

The last comment mentions Section 223(f)(3)(A)(i) which doesn't really clarify which code to use. However, the message also notes: "Because any normal (code 1) distribution from the HSA that is made taxable by not applying it to qualified medical expenses is applied against excess contributions, Forms 1099-SA distributions after the due date of the tax return to correct excess contributions should always have code 1. Using code 2 to also indicate distributions of excess contributions after the due date of the tax return would make it impossible for the IRS to determine the taxability of the distribution."

That last part is what makes sense to me as to why Code 1 should be used instead of Code 2.

Now the fun part – trying to explain this to my HSA custodian!

[dmertz]

Using code 2 instead of code 1 for a distribution that is required to be treated the same as a distribution reported with code 1 makes no sense.   Although the instructions form Form 1099-SA aren't entirely clear on this, it only makes sense to use code 2 for a return of excess contribution before the due date of the tax return, which is not possible for the $475.01 distribution.  If reported with code 2, TurboTax (and the probably the IRS as well) will treat it as nontaxable.  However, to eliminate the excess $475.01 from the HSA the distribution is required to be taxed and, if you are under age 65, be subject to a 20% penalty.  To resolve this excess, the $475.01 must appear on Form 5329 line 44 which is required to come from Form 8889 line 16, which will only happen if the Form 1099-SA has code 1.

[MrHarriet]

My HSA custodian got back to me and said they can process the 2022 and 2023 distributions like we described, @dmertz, by providing the information on Form 1099-SA and using Code 2 in Box 3. However, they are saying they have no way to manipulate the form 1099-SA to show my 2021 amount as a normal distribution (with Code 1 in Box 3) directly, and that it would need to be done either by me using the HSA debit card or by a reimbursement. They also warn this could cause headaches later if the IRS were to audit me.

They did say they could process all three years with Code 2 in Box 3 today, if that is how I wish to proceed.

While TurboTax may be confused by how I report this, if I were to file a paper return or some other means (such as Free Fillable Forms), couldn't I simply reflect the amount I owe in tax on Form 8889 anyway? I feel like this one little detail about Box 3 on 1099-SA is the only thing stopping me from getting this processed (finally!), and since the IRS isn't even clear about Box 3 – and who knows how many others from this HSA custodian are getting it processed as Code 2 – is it really a problem?

[dmertz]

"However, they are saying they have no way to manipulate the form 1099-SA to show my 2021 amount as a normal distribution (with Code 1 in Box 3) directly, and that it would need to be done either by me using the HSA debit card or by a reimbursement."

Right.  They should be making a regular distribution of $475.01 paid to you as if you were reimbursing yourself for qualified medical expenses that you had previously paid using other funds.  (Some HSA custodians charge a nominal fee for reimbursement distributions, sometimes depending on whether or not they need to issue a check for the purpose.)  You'll then make it taxable, thus eliminating this excess from the HSA, by treating the $475.01 on your 2023 Form 8889 as not used for qualified medical expenses.  That's exactly how it's supposed to be done.  This distribution will be combined on a 2023 Form 1099-SA that also reports other distributions made in 2023 that are used for qualified medical expenses.

[dmertz]

The HSA custodian needs to know nothing about the distribution of $475.01 being used to correct an excess contribution.   In fact, if you already have made distributions for qualified medical expenses in 2023 in excess of $475.01, you don't need to make any distribution of $475.01 now.  You'll simply report as used for qualified medical expenses the amount distributed for those expenses reduced by $475.01.