Mistake in calculation of excess contribution for HSA

[josyulakartik]

In 2019, I had HDHP insurance from March onwards. But, I started a HSA account in June 2019 through my employer. Since I had HDHP insurance throughout the year, I contributed $3500 for 2019 through employer contributions from payroll deductions. I left the employer in June 2020. Hence, I did not remain an eligible individual during my testing period (December 1, 2019 to December 31, 2020).

So, in order to withdraw my excess contributions of 2019, I requested the HSA trustee financial institution to withdraw the excess amount from my HSA account in July 2020. However, I made a mistake in this excess amount calculation. Instead of calculating excess amount for just 2 months of 2019 since I started with HDHP account in March 2019, I calculated it for 5 months since I saw that my HSA was opened in June 2019. The HSA trustee sent me the check for $1458.33 (=(5/12)*$3500) and filed a 1099-SA which indicated this amount as Excess Contribution. Since then, I have rolled over my HSA account to another new trustee and closed the account with the old trustee.

So, when I contacted the original HSA trustee regarding this mistake, they said they won't be able to do any changes from their end like generating corrected 1099-SA since I do not have an account with them. I am not sure how I show the $1458.33 in my tax return.

1) The actual excess contribution was $583.33. Does this mean I have to show the remaining $875 as distribution from HSA? But, the 1099-SA that the old HSA trustee sent me indicates clearly that $1458.33 was "Excess Contribution". So, can I by myself declare $583.33 as excess contribution and $875 as "Normal distribution" without any 1099-SA to show for it? I do have medical expenses for this amount in 2019-2020. But, I paid those expenses myself. Do the expenses have to be exactly $875? Or could they be more? Do I need to include any of these expenses or bills in my tax return?

OR

2)  Could I just include the 1099-SA details as $1458.33 by adding a 1099-SA in TurboTax when it asks for them? And then just mention that I had HSA since March 2019 and let $583.33 (automatically calculated by Turbotax) be the excess amount as automatically calculated by Turbotax? Should I do both of these or do only 1 of these? Is $875 considered a distribution?

OR

3) Could I just contribute the $875 difference back to my HSA with the new trustee since tax return due date is May 17 now? Could contribute back even if I am not under HDHP insurance now since it is just returning the mistake amount of excess contribution?

[BillM223]

This is more complicated than you think, because you did not have an excess contribution for 2019, you had a "failure to maintain HDHP coverage" in 2020, which is not cured by withdrawing "excess" contributions.

Can you see form 8889? You can if you have the CD/download software or if you have already paid for your Online product.

Please tell me the following from your 2020 return:

• The amount labelled "HSA" on the same line 8.
• The amounts on lines 18, 20, and 21 on your 8889.

From this, I should be able to describe to you what you should do.

[josyulakartik]

I am able to see my Form1040 which shows line 8 value as $583.

I am unable to see Form 8889 since I don't use use the CD/download software and I have not yet paid for the online product.

Could you help me with this information? Or do you need more details on my HSA contributions over 2019 and 2020 to answer?

Thank you very much.

[BillM223]

The $583 that you see on line 8 of Schedule 1 (1040) is almost certainly the same value as on line 18 and 20 on the 8889.

This is the amount of HSA exclusion that you took in 2019 that you would not have been eligible for had you not used the last-month rule in 2019. So this amount is added back to income in 2020.

In addition, you are charged a 10% penalty on this amount which is entered on line 21 of the 8889.

You will notice that there is no discussion of excess contributions here. That's because you don't cure the failure to maintain HDHP coverage by withdrawing "excess" contributions; instead, you pay income tax and a penalty on the amount you should not have been allowed to exclude from income in the previous year.

As for as the year 2019 is concerned, there were no excess contributions, because the last-month rule allowed you to use the full annual HSA contribution limit.

Now, as for your distribution in 2020, what you need to do is make a list of all the medical expenses you paid in 2020 with after-tax dollars, and apply as much of the $1,458.33 to those expenses as you can. You can add in any expenses in 2019 that were paid with after-tax dollars, so long as the expense was incurred after July 2019 (when you created your HSA).

This amount of reimbursed medical expenses is non-taxable. Whatever amount of the $1,458.33 that is left over will not only be taxable but subject to a 20% penalty. Thus, you are highly motivated to work on this list and have it available in case anyone from the IRS ever asks.

Yes, your HSA custodian will have this amount listed as a withdrawal of excess contributions, but you now realize that this was a mistake. Your paperwork will be correct, and you will be able to explain to any auditor why you did what you did.

To do this entry into TurboTax, you will enter the 1099-SA into the HSA interview. When TurboTax asks if the distribution was all for qualified medical expenses, you will have to answer "No", and indicate the amount that was left over (i.e., the amount that you could not tie to a qualified medical expense in the second half of 2019 or in 2020).

Had you not closed the old HSA, then you could have petitioned the old HSA custodian to accept that distribution as a "Mistaken Distribution" - you would have paid the $1,458.33 back and started over.

But I have seen that once an HSA is closed, the custodians don't like to reopen it (if they even are allowed to), so we can't fix this the elegant way.

"Could contribute back even if I am not under HDHP insurance now since it is just returning the mistake amount of excess contribution?" - You could do this ONLY is the old HSA custodian somehow allowed you to reopen the old HSA and then you convinced them to accept your return of the mistaken distribution. But they don't have to accept the Mistaken Distribution application, and we can't make them.

So, you can explain the situation to them and ask if you can reopen the HSA and return the Mistaken Distribution, in which case, you will send them a check for the $1,458.33, then spend it as needed for qualified medical expenses. But if they say no, then you will have to do what I outlined above.

[josyulakartik]

I found the information you asked for. 

Amount labeled "HSA" from Line 8 in Form 1040: $583

On form 8889:

Line 18: $583

Line 20: $583

Line 21: $58

Would you need any other information? Thank you very much.

[BillM223]

Nope, that what I expected from your line 8 entry on Schedule 1.

So put on your groveling face and talk to the old HSA custodian to see if there is any way they will reopen that old HSA long enough to let you return a Mistaken Distribution. If not, then you will have to report part of the 1099-SA distribution as not for qualified medical expenses and pay the penalty.

[josyulakartik]

Fortunately, I have more than $1458.33 for medical expenses between July 2019 and June 2020.  All of them paid by after-tax dollars. But, none of them sum up to exactly $1458.33. Will that be any problem?

However, the 1099-SA that my old HSA trustee gave me has the distribution code as 2 which is "Excess Distribution". So, when I enter this in Turbotax Deluxe during the HSA interview, it does not go the question of asking me if the distribution is for qualified medical expenses. I was just playing around and found that it asks that question if I use code 1 (Normal distribution) as the distribution code. But, then, it will be different from what I have in the 1099-SA with me. So, how do I go about this? Do I have to ask the old HSA trustee for a corrected 1099-SA which says this is normal distribution (code 1)? Is there any other way around this without involving the old HSA trustee? Can I just select distribution code  as 1 even though 1099-SA I have says it is 2?

[BillM223 · Accepted solution]

"But, none of them sum up to exactly $1458.33. Will that be any problem?" No, so long as the amount of documented expenses is more than $1,458.33. Anything not covered by the $1,458.33 can go to Schedule A, which probably means not go anywhere (most taxpayers can't reasonably deduct any medial expenses on Schedule A).

"the 1099-SA that my old HSA trustee gave me has the distribution code as 2 which is "Excess Distribution"." I was hoping that they had not done this. 

Yes, you are correct that the distribution code of "2" indicates that the box 1 amount (if any) is to be ignored and the earnings reported in box 2 are to be added to line 8 on Schedule 1 (1040).

Let's put it this way, you now know that you should not have asked for the withdrawal of excess contributions for tax year 2019, so you are trying to address this as best you can. 

If the old HSA custodian reopens the old HSA and accepts your request to return the Mistaken Distribution, then they are required to issue you a new 1099-SA (it's in the instructions for the 1099-SA). 

However, if that doesn't happen, then do these two things:

1. change the distribution code to "1" on the 1099-SA

2. manually add the amount in box 2 (the earnings) to Other Income which should appear on line 8 on Schedule 1.

Yes, we discourage taxpayers from altering forms and this may generate a letter from the IRS, but there may be no good way to fix this. All you can do is try to conform to the spirit of the Tax Code when there is no clear path available to you to resolve the issue.

Document everything you did and why, so that you will be ready to answer in case anyone from the IRS ever asks.

[josyulakartik]

The Box 2 (earnings) in the Form 1099-SA is $0. So, I think I can skip adding anything as Other Income on Line 8 on Schedule 1 

So, from what I understand of what you said, I will change the distribution code to 1 (normal distribution) on the Form 1099-SA information that I included in my TurboTax HSA interview and say "yes" when they ask if it has been used for qualified medical expenses. I will keep all the medical expenses with me.

I don't want to go about asking the old HSA trustee to reopen my old HSA so that I contribute the amount back as mistaken distribution since I have qualified medical expenses. They have already said that they can't issue corrected 1099-SA since my account is closed. If IRS asks in future about the discrepancy between 1099-SA that they have from my old HSA trustee and what I mentioned in the tax return, I could tell them the same and probably show the medical expenses if they ask for it.

I hope I followed what you were suggesting. Thank you very much for your patience in explaining everything and answering my queries.

[BillM223]

"If IRS asks in future about the discrepancy between 1099-SA that they have from my old HSA trustee and what I mentioned in the tax return, I could tell them the same and probably show the medical expenses if they ask for it."

Yes, if the IRS asks, explain that you did a Mistaken Distribution in the form of the withdrawal of excess contributions which were, in fact, not in excess. And because you subsequently closed the HSA, you were unable to fix the situation the right way, so you changed the distribution code in order to report the 1099-SA (better to report it wrong than to ignore it all together).

Then, if the IRS wants to talk to your HSA custodian about fixing this a more elegant way, they will have that opportunity. Otherwise, you have documented everything and are not holding anything back.

[josyulakartik]

Thank you very much for your detailed response and patience. I think I will make the change to the distribution code in 1099-SA and go ahead and submit my tax return.