What can I do with a refund from a closed HSA account?

[ray805]

Hi,

I just received a refund that I did not expect from a hospital from a visit in 2021.  I used an HSA account that has been long closed to pay the hospital bill.   Without notifying me, the hospital sent the refund to the administrator of my HSA account which in turn the administrator sent me a check.   I called the administrator and they said they will send me a form in January and also report the refund to the IRS.

I cannot open a HSA this year to deposit the check into because I have a FSA at work and not in a high deductible plan.    What can I do with the check without incurring taxes and/or penalties next tax year?  Thanks.

[Opus 17]

OK.  The first question is, can you "use up" the money by applying it toward 2024 medical expenses and not using the FSA?  If you can use up the money this way, there are no tax consequences.  However, you don't want to leave money in the FSA because that is use-it-or-lose-it, and that would be worse than the taxes on the HSA refund, which I will explain next.   You can also apply it to any unreimbursed medical expenses from 2023 and 2022, if you have them.  Just be sure to make a good record of your expenses, reimbursements, and leftover amounts, so that if the IRS asks questions, you can clearly show them that you applied the refund against other allowable medical expenses.

Any part of the refund that you can't use up against 2024 medical expenses should be reported on your tax return as a "reimbursement of a previous deduction", otherwise known as a "taxable recovery."  You didn't pay tax on the money because you used it for medical expenses, since those expenses were reduced and you got the money back, now you owe income tax on it (unless you can use it up against other expenses as I said).  Fortunately, there is no additional penalty for this situation.  Your withdrew the money in good faith in 2021 and your 2021 tax return was correct.  This refund is taxable (if you can't apply to other expenses) but there is no additional penalty. 

[ray805]

Thank you.  I will try to use it as a 2024 medical expense.   How will I present this in my tax return when I do my taxes next April?  Not sure if I've ever seen a line in the 1040 or any of the schedules where I put down that I used the refund as a 2024 medical expense.  The HSA administrator will send to me and the IRS a form showing its been refunded.

[Opus 17]

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@ray805 wrote:

Thank you.  I will try to use it as a 2024 medical expense.   How will I present this in my tax return when I do my taxes next April?  Not sure if I've ever seen a line in the 1040 or any of the schedules where I put down that I used the refund as a 2024 medical expense.  The HSA administrator will send to me and the IRS a form showing its been refunded.

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If you get a 1099-SA (distribution from an HSA), and you were able to apply the refund to other medical expenses, then you just enter the 1099-SA and when asked, check the box for "yes, I used all the funds for medical expenses."

If you get a 1099-SA (distribution from an HSA), and you can't apply the refund to medical expenses, there are two ways this could be handled, all of which will lead to the correct outcome, but with pros and cons.

1. Enter the 1099-SA for the refund, answer "yes, I used it all for medical expenses."  Then go to the section for "other uncommon income" or miscellaneous income, and click through until you get to "reimbursements of previous deductions" (or it might be called "taxable recovery"). Enter the amount of uncovered refund (the amount of refund not applied to medical expenses) as miscellaneous income.

2. Leave the 1099-SA off your return completely (it probably shouldn't be issued, actually).  Enter the taxable recovery as described.  File by mail, and attach a copy of the 1099-SA and a written explanation of why you did not include it on your return.  The reason is that if you entered the 1099-SA and indicated that only part was used for medical expenses, you would be charged income tax plus a 20% penalty on the uncovered part of the refund, but in this situation you should only be charged income tax and not the penalty.  But you can't enter this kind of explanation in turbotax and e-file, so doing it this way means you have to file by mail.  I would recommend #1.

[ray805]

Thanks Opus17!