What is expected HSA contributions in 5498-SA form if I remove excess contributions in February 2020?

[dumrinda]

Hi, I have HSA account transferred from previous employer. I'm not in high deductible medical plan, so I'm not eligible for HSA contribution. My HSA account is with same financial institution that have my saving/checking account. Now here is mistake happened - I accidentally had moved funds from regular checking account to HSA account on 6-April-2019. I had immediately transferred  back that amount on 7-April-2019.

On 3-February-2020, I spoke with bank person and they are going to issue 2 1099-SA forms. One form with distribution of type 2 (excess contributions) and another form with distribution of type 1 (normal distribution). Since form 5498-SA would be reported to IRS and me in May, I wouldn't know if my accidentally transferred amount is still reported as "contributions" on 5498-SA form to IRS or would it also be corrected to show $ ZERO contributions.

[BillM223]

I am going to assume that TurboTax reported that the first transfer into the HSA caused an excess contribution error message.

In this case, you would be permitted to contact the HSA custodian and ask for the "withdrawal of excess contributions". If this is what happened, then you should be in good shape.

The IRS instructions for box 2 on the 5498-SA (Total Contributions Made in 2019) "Any excess employer contributions (and the earnings on them) withdrawn by the employer pursuant to Notice 2008-59, Q/A 24, available at IRS.gov/irb/2008-29_IRB/ar11.html, should not be reported as a contribution."

See Instructions for form 5498-SA.

So if you asked the HSA custodian in April 2019 to request a withdrawal of excess contributions (the first transfer), then this amount should not appear in box 2.

Likewise, issuing a 1099-SA a year later with the earnings on the excess is normal, because the earnings spanned two tax years, and the IRS lets you report them in the second tax year.

If, however, you did not get the HSA custodian to document these transactions as "withdrawal of excess contributions", then you have a problem. 

The IRS does not permit willy-nilly transfers of money in and out of HSAs. In this case, you would have to report the first transfer as a contribution (even though you took it out the next day), take it as a tax deduction in 2019, and then report the distribution as a distribution NOT for qualified medical expenses, on which you will pay income tax and a 20% penalty.

First, ask the HSA custodian if they treated the second transfer as a withdrawal of excess contributions. If they did, you are probably OK.

Note that you will receive a separate 1099-SA for your regular distributions anyway; perhaps this is what the other 1099-SA is.

However, you should talk to your bank and make it impossible to accidentally transfer money into the HSA. 

[dumrinda]

Thank you @BillM223 for details.

I talked to HSA custodian on 03-Feb-2020 and they would be sending me two 1099-SA forms. I believe first one would be normal distribution and second is "excess contribution" distribution type.

I myself had transferred back from HSA account into checkin account in 2019 (immediately next day) but did not notify bank since I was unaware of tax implications. 

Since now I informed to HSA custodian before end of tax filing date (with extension) and what would be value on form 5498-SA in Box-2? Would it be still including "excess contribution"?

[BillM223]

The normal way to report this is:

• First transfer is a "personal" contribution to your HSA
• Second transfer is a distribution for non-qualified medical expenses.

The contribution will lower your taxable income. The distribution for non medical distribution will be added to your Other Income (thus, a "wash" with the contribution) but you will also pay a 20% penalty on the distribution.

Note that you can reduce this effect if you get the excess contribution error message in TurboTax. You might see this when you add the first transfer as a personal contribution.

If this happens, then agree to withdraw the excess by April 15, 2020. Then contact the HSA administrator and request the withdrawal of an excess contribution. Call this amount X. 

If you tell TurboTax that you will withdraw the excess, then TurboTax will reduce your contribution to zero. At the same time, you should contact your HSA custodian and report a "mistaken distribution" in the amount of the value of the second transfer minus X. 

Be nice because the custodian does not have to accept this request, but if they do, they are required by the IRS to give you a corrected 1099-SA.

Note: you will still get credit for the amount of the first transfer that was not excess as a contribution to the HSA, and you will still report the amount of the second transfer less the mistaken distribution as income and be penalized on it...but the amount of the penalty should be less.

What you cannot legally do is just take out the amount you put in by mistake. The HSA is not a simple savings account that you can give to and withdraw at will.

I know this is complicated, but I am trying to minimize the penalty you are going to have to pay.

[dumrinda]

Thanks @BillM223 again. Yeah, it is indeed complex and confusing. I read your latest message several times 🙂

I'm trying to parse this text from your latest message:

Note: you will still get credit for the amount of the first transfer that was not excess as a contribution to the HSA, and you will still report the amount of the second transfer less the mistaken distribution as income and be penalized on it...but the amount of the penalty should be less.

1. Does green text mean, it would go on 5498-SA as "contribution"?
2. Does pink text mean, it would go on 1099-SA form as "normal distribution" (but non-qualified medical)?

[BillM223]

I am having rewrite my answer.

There are two issues:

1. The transfer to the HSA which is a contribution.

2. The transfer out of the HSA which is a distribution.

You can contribute to an HSA whenever you like, but you are subject to annual contribution limits. I don't know if this first transfer exceeded the annual limit for you or not. You should report it on the "Let's enter [name]'s HSA contributions" screen on the second line (the first line is the code W amount in box 12 of your W-2).

This may or may not trigger an excess contribution message (it depends on what else you have contributed), but if it does, then, if you have the money in the HSA,tell TurboTax that you will withdraw the excess before April 15th 2020. Then contact the HSA custodian and request a "withdrawal of excess contributions". They will send you a check for the excess being withdrawn.

Note that this means that whatever amount was not in excess is still considered a contribution, and you can't undo that. At least you will get a tax break from it.

As for the second transfer, this was a mistaken distribution, plain and simple. The first thing you should try is calling the HSA custodian and explaining that you did not intend this distribution at all - you were just trying to fix your mistaken contribution. Request that it be treated as a mistaken distribution.

Be nice, because they don't have to accept this request. But if they do, then they will ask you to send them a check for the mistaken distribution. If you can send it to them, then they will issue you a corrected 1099-SA. This will prevent you from having to enter that this was a distribution for something other than medical expenses - and get rid of the 20% penalty, too.

So, on the one hand, you may be getting some of the first transfer back as a withdrawal of excess contributions. On the other hand, you have to send the custodian the total amount for the second transfer (if they accept it as a mistaken distribution). Obviously, the larger the excess is, the easier it will be to pay back the mistaken distribution. If the entire first transfer is excess contribution, then this whole thing is a wash - you just have to do it this way so that the HSA custodian will get the paperwork correct.

But do try to pay back all of the mistaken distribution back, because any part you can't pay back you will be taxed on and have a 20% penalty.

Also, please ask the custodian to see if they can block you from being able to transfer money out of the HSA. You want to do this only on purpose, and one way to do this is to force yourself to have to call the custodian if you ever need to be reimbursed for something. This should not happen often (if ever) if you have the debit card to use for regular medical expenses.

So, two things to start with:

1. enter the first transfer as a contribution and see what it does.

2. contact the custodian about the mistaken distribution.

Let's see if you have the cash flow to pull this off.