Hello
In 2022, my wife overfunded her HSA by $703 and in 2022, 2023 and 2024, we paid 6% excise tax on the $703. In tax year 2025, we distributed the $703 out of the HSA and received a 1099-SA which included the $703 in box 1 and box 3 has code 2 for excess contribution.
The questionnaire wizard for the form does not make sense. How do i enter this information for 2025 so that i do not pay excise tax on the $703? Also, is this distribution considered taxable income? If so, how do I enter the information so that it is taxable income but no excise tax being triggered? Note, that my wife is no longer covered under a high deductible health insurance plan as of 2023, 2024 and 2025. She is not employed. She still has an HSA.
I was in the phone with Turbotax for over 2 hours and no one had any idea on how to help me resolve this issue nor knew the answer. Here are some facts and general conclusions I am drawing that I need help with vetting. In 2022, I can see on my 1040 that the $703 excess was included as "Other Income" line 8 and I paid an additional 6% excise tax on the $703 for that year. In 2023 and 2024, I only paid 6% excise tax on $703 since it wasn't withdrawn.
My approach for 2025 is as followed: In tax year 2025, I did work with the HSA provider and the $703 was distributed out of the account so my thinking in the following in terms of how to handle this and make the software work. Form 8889 Part II line 14a and 14b will show the $703, form 5329 will no longer need to be included since the excess $703 was removed from the HSA via the 1099-SA and the $703 distribution is not included in "Other Income" for tax year 2025 because I paid incomes taxes on that amount back in 2022 as supported by my return. Does this approach make sense?
Enter the 1099-SA as you received it.
Yes, the Box 1 amount ($703) will be added to income, but for the last time. However, TurboTax sees this distribution and uses it to cut off the carryover without you having to do or enter anything special.
Just enter the 1099-SA and the carryover of the excess contribution will be done with.
Bill thanks but the software isn't doing as you say and it is important to note the years this excess distribution is related to. I paid income tax back in 2022 in the year in which the HSA was overfunded and a penalty (6% excise tax). In 2025, i distributed the excess out of the HSA. Do we agree that no excise tax would be owed as of 12/31/25 since there is no more excess?
Back to the income tax part related to the distribution that occurred in 2025. What doesn't make sense to me is why I would pay income tax in 2025 when the money was distributed when I already paid the income tax back in 2022, the year in which it was overfunded? I understand the concept of "additional tax" in the form of excise owed due to the money not being pulled out, that penalty is separate and district from income tax. From an income tax perspective why would the distribution be taxed again in 2025?
Code 2 was incorrect, this could only be used if the excess was returned within the original deadline (April 15, 2023). This should be code 1 (normal distribution).
To remove the excess contribution, this must be reported as a regular withdrawal that was not used for medical expenses. That will subject it to income tax plus a 20% penalty, but it will remove the ongoing excess issue.
As to why you have to pay tax again? Because that's the rule. All withdrawals that are not used for medical expenses are subject to income tax plus a penalty. The fact that a withdrawal not used for income tax is the only way to clear an excess when you miss the intended deadline (April 15 of the next year) is unfortunate, but that's how the law is written.
The other solution would be to leave the excess in the account and keep paying 6% (instead of paying 22% plus 10%) until you re-enroll in an HDHP and are eligible to make new contributions again, or you spend the account down to zero.