Correcting an excess HSA contribution from long ago

[pavben]

January 2022: Employer made an excess contribution to my HSA of $100.

Feb 2023: Doing taxes and realized that it is an excess. Indicated in TurboTax that I will withdraw it before the deadline to avoid the excise tax.

March 2023: Withdrew $100, but I messed up. I withdrew it as a normal distribution instead of a return of excess contribution.

March 2024: Doing taxes and realized that the withdrawal was done wrong.

Now I have:

1. An excess contribution of $100 (+gains or -losses) from 2022.

2. Possible unpaid excise tax on the excess contribution for 2022 and/or 2023. Note that for 2022, I indicated in TurboTax that I would withdraw it before the deadline.

3. An early withdrawal of $100, plus any applicable penalties, in March 2023.

This would be easy if the HSA custodian would re-code the distribution from March 2023 as a withdrawal of excess, but they claim they cannot do anything about this since the original contribution was back in 2022.

I'd like to deal with the excess contribution to restore the HSA to a state where there is no excess, and undo any unnecessary early distributions done in 2023. Could someone point me to the tools available for this?

Thanks!

[BillM223]

Let's try this:

1. You'll need to calculate the earnings on the excess while in the HSA. If there was anyone friendly at the HSA custodian, you could ask them to calculate it even if they can't do a withdrawal for 2022 any longer (And, no, no HSA custodian would do what you would like about the recoding). If you can't get it from the HSA custodian, you can go to this link which describes how to calculate earnings on excess IRA contributions (the calculation is the same for HSAs).

2. Now for your 2023 tax return, get into your HSA interview. When you are asked if you overfunded your HSA in 2022, answer YES, then enter on the next screen the amount of your excess (the $100).

3. Depending on your other entries, TurboTax might calculate excess contributions for you this year. If so, you won't be able to withdraw the excess from 2022 (the overfund amount that you entered), just the 2023 excess. Do so.

4. On the other hand, if there is room under your annual HSA contribution limit for 2023, the excess from 2022 will be applied to your 2023 limit as a personal contribution, and "used up". This will get rid of the excess carryover.

5. Go to Wages & Income->Less Common Income->Miscellaneous Income->Other reportable income, and click on Start. Answer YES to did you receive any taxable income. On the next screen, enter the description of "earnings from excess HSA contributions" and then the earnings from step #1.

6. You still have a 1099-SA from early 2023 for $100 miscoded as a normal distribution. Do you have $100 (or more) in current medical bills not reimbursed from the HSA, or perhaps will you have $100 or more in medical bills in the near future? In the latter case pay them from the $100 in your checking account, and only the rest of the bill (in excess of $100) from your HSA.

7. If you can apply the $100 to any recent or new medical bills, then just marked it as not for qualified medical expenses, which will add the $100 to income as well as impose a 20% penalty.

8. Document everything you did and keep it in your tax files in case any one ever asks. The point is that you need to show that you tries to take corrective action, even when the rules by the IRS for doing so are not very clear.

9. If you do all this, you should have purged your HSA of excess contributions and declared the earnings as income, and you should be back to where you started with your HSA.

[pavben]

When you say to withdraw the 2023 excess, how can I do that? The HSA custodian (Fidelity) seems to have only two relevant options for withdrawals:

1. Return of excess contribution form, which I cannot use because the contribution was from too long ago (2022). I confirmed it with them multiple times.

2. Normal distributions, which would generate the kind of 1099-SA that I received for my March 2023 withdrawal, with distribution code 1.

The custodian is telling me that my tax advisor should be able to sort this out with the IRS and are not offering any alternatives. If those are the only two tools they have available and I have to do a withdrawal anyway and receive a 1099-SA with distribution code 1, can I take that 1099-SA that I received and treat it as two separate 1099-SA forms?:

1. Return of excess contribution ($90: Not $100 because there is a $10 loss on the HSA from Jan 2022 to March 2023).

2. Normal distribution ($10) that I will apply against medical expenses.

... and be done with it? IRS will see a mismatch in what I filed and what the custodian reported because all they got was a 1099-SA showing a $100 distribution, but there has to be a way to explain that to them (if asked or audited, or even proactively) since the custodian isn't offering me any other options.

[BillM223]

"When you say to withdraw the 2023 excess, how can I do that? The HSA custodian (Fidelity) seems to have only two relevant options for withdrawals:

1. Return of excess contribution form, which I cannot use because the contribution was from too long ago (2022). I confirmed it with them multiple times.

2. Normal distributions, which would generate the kind of 1099-SA that I received for my March 2023 withdrawal, with distribution code 1."

You did not understand what I wrote. I wrote, "3. Depending on your other entries, TurboTax might calculate excess contributions for you this year. If so, you won't be able to withdraw the excess from 2022 (the overfund amount that you entered), just the 2023 excess. Do so."

Let me say it again: If TurboTax tells you that you have an excess for 2023, you can withdraw any part of that excess that is not part of the carryover from 2022.

Steps 4-7 are how you deal with the $100 carryover from 2022 - as you note, it is NOT done by "withdrawing an excess contribution".

"The custodian is telling me that my tax advisor should be able to sort this out with the IRS and are not offering any alternatives." - this is no surprise. I have laid out a path for you to get your HSA back to normal. That is not the HSA custodian's job, and, frankly, the custodian generally knows less than they think they do.

"can I take that 1099-SA that I received and treat it as two separate 1099-SA forms?:

1. Return of excess contribution ($90: Not $100 because there is a $10 loss on the HSA from Jan 2022 to March 2023).

2. Normal distribution ($10) that I will apply against medical expenses."

Steps 6 and 7 describe how to handle this, without you changing the distribution code in the 1099-SA that you have already received (plus you splitting the 1099-SA into two). You express concern about the IRS not understanding what you did (which is good), but the way I outline involves less violence to the process. 

In any case, "but there has to be a way to explain that to them", but there is no way in the current IRS instructions for you to explain this to them, so don't try. Just document everything we talked about here and what you did, in case anyone ever asks. Given the lack of IRS instructions for the HSA process and form 8889, it's all you can do.