Excessive HSA contribution question

[gonglien]

I overfunded my HSA for tax year 2023 and found out in 2024 while filing tax. I withdrew it before 4/15/24 to avoid the penalty. However, I accidentally withdrew it as normal distribution and my 1099-SA is not correct now. When contacted my HSA account manager, they insisted I had to return the money to HSA account then withdraw it correctly. This for sure is not going to be done 4/15/25 and I am afraid that I will have to pay tax again for $3650 that I already paid in 2024, on top of 6% penalty. What’s is the best way to correct this?

[BillM223 · Accepted solution]

As I see it, you have two choices:

1. Go through the process that the HSA custodian suggested, making sure that you request the withdrawal of the excess contributions by April 15th, even if the money doesn't get to you before April 15th. Document everything in case anyone ever asks.

2, Change the distribution code on the 1099-SA to "2". 

   #2 has one advantage and two disadvantages. The advantage is that you can do this now.

   The disadvantages are that (1) you are changing a tax form that the IRS has a copy of, so this may generate a letter from the IRS to you, and (2) you will have to calculate the earnings yourself for the period of time that the excess was in the HSA and enter it in box 2 of the 1099-SA. 

Hmmmn, I guess there is a third alternative.

Ask the custodian to treat the distribution as a Mistaken Distribution (see "HSA Mistaken Distributions" in the 1099-SA Instructions). Note that these are instructions to the HSA custodian, not you. Also note that they don't have to accept this request, so be nice.

You will have to send them a check for the amount of the Distribution.

Then, because you did not withdraw the excess in time (go through the HSA interview again, and tell TurboTax that you are not withdrawing the excess), it will be carried over to 2025. You will be dinged 6% of the carryover. But if you reduce your HSA contributions for 2025, the carryover will be placed on line 2 of the 8889 and used as a personal contribution. If you don't generate a new excess, then the carryover will be "used up" in 2025, with no further problems.

Oh, there is a fourth alternative  ("on the fourth hand..."), which is to extend your return. You then have until October 15th to withdraw the excess (you still have to get the money to the HSA custodian by April 15th). This means, of course, that you will either paperfile or look into how TurboTax e-files amended returns.

See the Instructions for the 5329.

[gonglien]

Thank you so much for the solutions. You are AWESOME! I am leaning the third alternative: my HSA custodian already asked me to mail a check back with the distribution as a Mistaken Distribution so that part is taken care of. She suggested to remove excessive distribution as a second step but I prefer your suggestion of taking 6% ding but carry that to 2025 HSA (I am making sure my contribution doesn’t exceed limit with the carryover this time). But my question is, the excessive contribution was from 2023, not 2024 - would it be any problem to carry that in to 2025? 

[gonglien]

Another question is that if I do return the “mistaken distribution” and remove it as “excessive contribution” now, do I have to pay income tax on the excessive contribution again? I already paid that in last year’s return and I am assuming turbo tax will treat that as part of my income again this year and I have to pay tax twice, since I didn’t withdraw it correctly.

[BillM223 · Accepted solution]

"But my question is, the excessive contribution was from 2023, not 2024 - would it be any problem to carry that in to 2025? "

This would be fine; in fact, it's supposed to work that way - if you can't take as a contribution one year, you can take it in the next.

"if I do return the “mistaken distribution” and remove it as “excessive contribution” now, do I have to pay income tax on the excessive contribution again?"

Yes. The 2023 excess contribution was supposed to have been removed by April 15, 2024. If you remove it at any time after that point, then it will be reported as income with a 20% penalty.

Your choice of #3 does have the following implications:

1. Your 2023 return should have showed excess contributions being carried over to 2024 (which you are going to carry over to 2025). I assume that your 2023 return did not because you said you were going to withdraw it. This means that you will need to amend your 2023 return to generate that carryover (by telling TurboTax that you will not withdraw the excess by April 15 2024).

2. This would generate an entry in the Carryover Worksheet (yes, that's how we communicate things from one year to the next). 

3. But you want to file your 2024 return now. That's OK, because TurboTax asks you in the 2024 HSA interview, "Did you overfund your HSA in 2023?" Answer yes, and then enter the amount of the excess that you know that 2023 is going to show. This will apply the carryover from 2023 to 2024 (I don't know what contributions you already made in 2024 - maybe part of the 2023 carryover can be used in 2024?). 

4. Then when the 2024 TurboTax tells you that you have an excess, TurboTax will limit how much you can withdraw to only excess derived from 2024, not from 2023. Withdraw whatever you can, otherwise let the rest carry over to 2025, where you will finish it off.

5. Fortunately, the filing of 2024 does not depend on amending 2023 first, so file 2024 now, and amend 2023 when you get around to it later this year.

[gonglien]

My HSA in 2024 was fully funded so I have to carry this amount to 2025. Your replies are super helpful. Now I know what to do and once again I appreciate your help so much!

[KrisD15]

When you DO use the HSA, you will get Form 1099-SA and that form shows the account balance. 

The only time the IRS gets involved is when the account is over-funded in a year.