Fix HSA prior year excess contribution mistakes

[Cosmo145]

Tl;dr I had excess contributions in 2024 and I didn't correct them by the 2025 tax filing deadline. Now in 2026 I tried to fix it by asking the HSA custodian to withdraw that amount as 2025 excess (which is incorrect). Not sure how to fix it or what to put on form 8889.

Full story:

1. In 2024 my employer contributed $5000 (via payroll) to my HSA (family coverage HDHP) but then I found out I was disqualified for the whole year 2024 because my spouse had an FSA - which means I had an excess of $5000 for 2024.
   
   1. I didn't withdraw the excess $5000 on time, so I let TurboTax fill in all the extras I need to pay (6% excise tax, add it to income etc)
2. In 2025 I was back to being eligible (family coverage), so my employer contributed another $5000. 
3. I read that the excess $5000 from 2024 "carries over" to 2025, so $5000 (2024) + $5000 (2025) brings the balance at the end of 2025 to $10,000. The contribution limit was $8,550 for family, so I was still in excess $10,000 - $8,550 = $1,450 for the year 2025.
   
   1. If I had left it at that, I would only owe another 6% on that $1,450, but:
4. Mistake: I didn't quite understand how withdrawal of excess contributions works, so I asked the HSA custodian to withdraw $5000 ( + earnings on it) for the year 2025 as excess contributions (I did that now in 2026, after the 1099-SA was issued). I then found out that technically that's not a withdrawal of excess contributions, instead it's a distribution for non-medical expenses which will be taxed at 20% + added to income

What are my options now?

A. Pay the 20% penalty on the full $5000 ( + earnings) + add that amount to income

B. Declare the $1,450 portion ( + apportioned earnings) as the correct withdrawn excess contribution on Line 14b of 8889 and the remaining $3,550 ( + earnings ) as non-medical expenses - Line 16 on form 8889?

[BillM223]

If I read your story, right, on your current (2025) return, TurboTax told you that you had an excess contribution of $1,450. The easiest thing to do would be to let that carryover to 2026 if you expected to have HDHP coverage throughout 2026. Yes, you will be hit with a 6% of the carryover penalty this year, but so long as you can persuade your employer to contribute a smaller amount so that you stay under the Family coverage limit, the carryover will be applied as a personal contribution, and it will disappear.

What was the distribution code on the 1099-SA that you received? '1' or '2'? How you proceed from here depends on your answer.

[Cosmo145]

Hi,

Thank you for looking into this! Yes, in TurboTax the resulting excess on Form 5329 boxes 46 (and 48) comes to $1450 (I did change my actual numbers for this post to make them easier to read, i.e. my contributions each year weren't exactly $5000 but close)

The problem is I thought I can "fix" the original excess from 2024 by instructing the HSA custodian to withdraw $5000 as excess contributions for the year 2025 (I was thinking "take out $5000 from 2025, make room for the carryover excess $5000 from 2024"). I did find out afterwards that that's not how excess withdrawal works, so I'm trying to figure out what to do now.

I received a 1099-SA before doing any of these operations, so the only distribution code there is 1, for regular medical expenses from last year.

[BillM223]

Contact your HSA custodian and ask them to consider that $5,000 withdrawal as a "mistaken distribution". This will require you completing a form and you sending the $5,000 back to them. They don't have to do this, so be nice...grovel if you have to.

Then turn around and ask for a withdrawal of excess contributions of $1,450 plus earnings (please ask them to calculate this - although more and more HSA custodians are getting lazy and declining to do it). This next 1099-SA will arrive sometime between your request and late January 2027, but it goes on your 2026 tax return. So you might not see the new 1099-SA for a while.

[Cosmo145]

I made 1 attempt to ask them to consider it a mistaken distribution and they refused, but I'll try again.

If that doesn't work, do I report the $5000 as taxable distribution? Do I do that for the 2025 return or do it next year for the 2026 return? Can I still "split" it into $1450 excess withdrawal and $3550 taxable distribution?

[BillM223]

If this is the case (no mistaken distribution), then your plan to split the 1099-SA has some up sides and downsides.

If you enter for the 2026 tax year (i.e., next year) two 1099-SAs, one with dist code of '1' and $3,350 as the distribution and earnings reduced by the prorated amount of 1450/3550, and the second 1099-SA with a distribution code of '2', the distribution equal to 1,450 and the earnings being whatever you didn't report on the first 1099-SA, there are the Pros and Cons:

Pros:

This is exactly what should have happened - and you can tell that to any auditor. 

Your tax numbers on the return are correct, in terms of income tax and penalties on the 5329.

Cons:

When you change a filed form (i.e., one copied to the IRS like the 1099-SA is), you increase the risk of getting a letter from the IRS.

However, the letter from the IRS is more a point of curiosity on their part - they are saying "we think this is the right tax, but would you please explain the difference?" It is not an accusation of wrong behavior.

Just document what you did and why you had to split the 1099-SA that you will receive (I guess you haven't received the $5,000 1099-SA yet, right?), and save it in your tax file in case anyone ever asks.

Do the right thing, and don't fret over it.

[Cosmo145]

Extra question: since it's before April 15, if I make a personal contribution for the year 2025 in the amount of  $3,550 (given the $5000 was withdrawn under code 2 - excess contributions), doesn't it even out?

(Please stop me now if I'm making things worse)

Something like this on form 8889:

Total contributions: $5000 + $3,550 (+ carryover $5000 from 2024)

Total distributions: $5000 code 2 + earnings on distributions 

Total taxable distributions: 0

Totals for the year 2025: $5000  (2024) + $5000 (employer, 2025) + $3,550 (me) - $5000 (code 2) = $8,550 

[BillM223]

"(Please stop me now if I'm making things worse)"

Yes, please STOP ;-).

That would seem to make sense, except that the only ways to fix an excess contribution that is beyond the original due date (or extension, if you extend your return) is to take a distribution with a code of '1' (and pay the 20%) OR use it up in the next year if you still have HDHP coverage and have reduced your regular HSA contributions so that the original excess will fit under the limit as a "personal" contribution (line 2 on form 8889).

In other words, you don't link a 1099-SA with a code of '2' to any particular excess.

So don't make the $3,550 contribution for 2025, because it will just create more excess.

Go ahead and let the $1,450 carryover excess be used up in 2026 as a personal contribution (line 2 form 8889), and be done with it. Yes, you will have been penalized for withdrawing the extra $3,550 for 2025, but that's OK because that is what should have happened. You should have an excess of $1,450 carried over to 2026, but if you have have Family HDHP coverage for 2026 and you can fit the $1,450 under the contribution limit (which you should be able to if your employer sticks with the $5,000/year contribution), then the last excess of $1,450 will be used up, and you will be done with it.

[Cosmo145]

Thank you so much for all the information!

One more clarification: if I then report the "split" on the 2026 tax return next year, $1,450 being distribution code 2 and $3,550 being distribution code 6(?), isn't that technically incorrect given the withdrawal was made before April 15?

Also, how do I convince Turbo Tax to add either amount back to taxable income? (given it was put in my HSA pre-tax, I now owe tax on it as regular income) Do I manually add it to the amount from W-2 Box 1?

[BillM223 · Accepted solution]

I apologize but this is the curse of HSAs - they lend themselves to such convoluted situations that one can easily make a mistake.

OK, ignore what I said about making a 1099-SA with a distribution code of '2'. Since, as you pointed out, the original excess of $1,450 was not withdrawn in a timely manner, you can't do a 1099-SA with code '2' later.

As I noted above (but have trouble remembering all the details), the only way to cut off the carry over of the excess after the original due date is to do a "normal" distribution (code '1'). The problem is that you DID withdraw that $5,000 but you can't use it as a withdrawal of excess contributions (code '2') because it was done too late. 

However I may have another alternative. The IRS allows you to withdraw money in a "normal" distributions to repay your self for otherwise unreimbursed medical and dental expenses that you have incurred since the HSA was created.

Do you have any medical or dental expenses that you incurred since the date you created the HSA (generally the date the first dollars landed in the account) that you paid for out of pocket? Then you can apply part of the $5,000 to those expenses. You need to document this in case anyone ever asks. And if you do this, you will need to tell TurboTax when you enter the 1099-SA that part of the distribution was for qualified medial expenses. When TurboTax asks, tell it how much of the 5,000 was for qualified medical expenses. In this case, TurboTax will add only the difference to Other Income.

The preceding is clearly in the IRS rules; however, the IRS has been vague about withdrawing money for a future medical expenses. Is next month OK? 3 or 4 months? Not clear.

But if you have a medical expense that you might do shortly, you can add this to the medical expenses number when you enter the 1099-SA. But you will have to document (for your own tax files) which expenses you are applying to this distribution. This might motivate to stop putting off new glasses or contacts or getting that new crown.

[Cosmo145]

Right, but at this point I feel like I don't fully understand what the IRS considers excess for a given tax year (apologies for going back to the top for a bit):

In 2024 - I contributed $5000, the limit was 0 (not eligible) -> excess of $5000

In 2025 - I contributed $5000, the limit was $8,550. With the $5000 carryover from 2024 means I had "room" for only $3,550 for 2025, so my $5000 contribution bring the total over the limit by $1,450.

Doesn't that technically mean that in 2025 I had excess contributions of $1,450 that I am allowed to withdraw this year before Apr 15? 

Or is it the opposite - the 2024 carryover doesn't affect the limit for 2025 so my 2025 "excess contributions" are $0 because I contributed $5000 which is below the family coverage limit, $8550?

If it's the latter then the only option is to pay the penalties on the $5000 withdrawn, on the 2026 tax return

[Cosmo145]

Please ignore the previous reply - I now understand what the option is.

Curious about one thing: if I already added the $5000 that I overcontributed in 2024 to the income reported on the 2024 tax return, is it true that as a non-medical distribution I will have to once again add it to the reported income for the 2026 tax year, essentially being taxed twice on the same amount? (on top the 20% penalty that I owe for the non-medical distribution)

Note I don't have any unreimbursed medical expenses to offset the amount here.

[BillM223]

Yes, in the case that you had excess HSA contributions contributed through your employer, which were not withdrawn in a timely manner, then you would end up paying tax on the excess twice.

But, really, only one extra time. If you think about it, the excess should have been taxed the first time anyway, so you are paying tax only one extra time. So there is a real penalty for not withdrawing your excess contribution by the due date of your original return (as extended).

[Cosmo145]

But that's the thing - TurboTax already added the amount to income on the 2024 tax return, so I paid taxes for it (and the 6% excise tax).

Next year if I add it as a taxable distribution on Form 8889 (as discussed above) TurboTax will again add it to my income and I'll pay income tax for it one more time.

[BillM223]

Yes, that's right. As I said, if you make an excess contribution through your employer and don't withdraw the excess in time, then the excess is taxed again if you make a later withdrawal.

When HSA contributions are made through an employer, then the code W amount is removed from Wages in boxes 1, 3, and 5. So you are getting a big tax break in the original year, because the code W amount is not taxed at all.

If TurboTax detects excess employer contributions, then the excess is added back to income in the original year.

If you withdraw the excess in a timely manner (prior to the due data of the return (as extended), then the excess is taxed only that once.

But is you fail to withdraw the excess is a timely manner, then if you withdraw the excess later as a normal distribution, yes, the excess will be taxed again.

The only way to avoid this is to have HDHP coverage in a future year, and using the carryover excess as a personal contribution in the future year, so that the carryover is used up, as I said in my first response:

The easiest thing to do would be to let that carryover to 2026 if you expected to have HDHP coverage throughout 2026. Yes, you will be hit with a 6% of the carryover penalty this year, but so long as you can persuade your employer to contribute a smaller amount so that you stay under the Family coverage limit, the carryover will be applied as a personal contribution, and it will disappear.