How to account for HSA Return of Excess for 2020 Taxes?

[Csaec1204]

Hello,

I'm confused with how to account for my scenario in the TurboTax Deluxe software.

In 2020 I was eligible for HSA for a few months at the end of the year, so I maxed it out at the individual limit ($3550). This is automatically taken through payroll (and shows up as $3550 on my 2020 W-2 in box 12 code W). With changes in employment for 2021, I now realize I will not pass the testing period. 

I am planning to request a return of excess from the HSA provider next week, to be sent back to me as a check. They mentioned they will send me a 1099SA form in early 2022 that reflects this after I complete the request.

1. How do I document that excess amount on the TurboTax software for 2020 federal taxes? Do I manually list its value under "Miscellaneous Income"> "Other reportable income", and title it as "HSA Excess Contribution"? 

2. Alternatively, if I step through the HSA section, I get asked questions of if I overfunded my HSA in 2019 (answered "no" since I was fully eligible that specific year), but the final question asks about if I have "additional income under the last month rule". Is this where I would list the excess value? The notes section on that screen comments that this is for if my marital status changed, so I'm not sure if this is right. 

3. Am I supposed to list the original over-contributed amount, or include the value that includes the earnings/losses (which the HSA provider told me they would calculate when sending me a check back)?

4. Is there a separate section on the state tax area that I also have to account for this excess HSA amount?

Thanks in advance for help!

[BillM223 · Accepted solution]

This is not considered an excess contribution, at least, not in the way you think. This is "failure to maintain HDHP coverage", which is taxed a different way.

The way this is rectified is like this:

1. TurboTax realizes that you didn't have HDHP coverage for every month this year (2020) (the testing period).

2. In response to a question ("What type of High Deductible Health Plan did [name] have on December 1, 2019?"), TurboTax realizes that you could have used the last-month rule in the previous year (2019).

3. TurboTax asks you what you contributed in the previous year (2019) and what kind of HDHP coverage you actually had in the previous year (2019) month by month.

4. From this TurboTax calculates how much you should have been able to contribute, had you not used the last-month rule.

TurboTax will tell you that it is going to add an extra $X.XX as income on line 8 of Schedule 1(1040) with the text of "Form 8889 Health Savings Accounts" AND a 10% penalty of $X.XX or so on line 8 of Schedule 2 (1040) with the text of "HDHP".

So, in short, this is not treated like excess contributions at all, and you don't withdraw anything. If you want to know more - or have insomnia - you can read all about this in the Instructions for form 8889.

I realize I did not answer your questions one by one, so read what I said above and see if you still have questions.

[Csaec1204]

Hi @BillM223!

Thanks for the response. To clarify:

- In 2019: I was fully eligible for the HSA every month

- In 2020: I had a HSA-eligible HDHP but also another insurance plan (that was non-HDHP) for the majority of the year, but in the last few months, reverted back to just having the 1 HSA-eligible HDHP, so contributed $3550

- In 2021: I realize with job changes I will lose this HDHP sometime next month. At this point I've only contributed a few hundred to my HSA for 2021 and will no longer.

Is the 2020 scenario still treated as "failure to maintain HDHP coverage"?

Stepping through the questions you listed below, I end up getting a "good news, you don't need to include any income under the last-month rule". 

Does this mean I would not see any income penalty when doing 2021 taxes next year? When doing 2021 taxes next year, would I have to do any kind of withdrawing at that time?

[BillM223 · Accepted solution]

In 2019, you did not use the last-month rule*, because you had coverage every month.

In 2020, you DID potentially use the last-moth rule* because you acted as if you were able to use the full annual HSA contribution limit even though you did not have HDHP coverage for each month free of any conflicting other coverage.

In 2021, when you do the HSA interview, TurboTax will realize that you did not have HSA coverage all year. So it will innocently ask you what type of HDHP coverage you had on December 1, 2020. 

Based on your answers, TurboTax will suspect that you used the last-month rule* in 20200 (and you did), so will ask you a series of questions that will result in TurboTax figuring out your allowed contributions without the last-month rule* and adding it to your Other Income along with a penalty.

You got the message "good news, you don't need to include any income under the last-month rule" in 2020, because you in fact didn't use the last-month rule* in 2019 - you had coverage every month.

You will fail to maintain HDHP coverage in 2021, however, and thus will answer the same questions but this time not get the good news.

*Last-month rule

The last-month rule, as it seems that you know, is a special rule that allows to use to the full annual HSA contribution limit even if you did not have HDHP coverage for each month, so long as you had HDHP coverage on December 1 of the tax year. In short, this is a retroactive adjustment to your HSA contribution limit to make it possible to act as if you had HDHP coverage each month, even when you didn't.

The only catch is that you must keep HDHP coverage during the "testing period", usually the next 12 months. If you fail to maintain HDHP coverage during the testing period, then your actual HSA contribution limit is calculated based on your information without the last-month rule, and any excess amount of contributions under the revised contribution limit will be added to Other Income and a penalty assessed.

It is correct that you did not have this failure to maintain in 2020 because you didn't use the last-month rule in 2019, but since you did in 2020, it will catch up with you on your 2021 return.

Make sense?

[Csaec1204]

Hi @BillM223 ,

That makes sense on the catch-up, that it will be a penalty for when I do the 2021 taxes next year. 

When I do the 2021 taxes next year, once I get the bad news and the software adds the excess as Other Income that I will pay the 10% penalty on, is that the final step (and I will not need to do any excess withdrawing from the HSA account at that time)?

Thanks for your help with all of my questions!

[BillM223]

No, there will be no need to withdraw anything...as I noted, this is not a case of "excess contributions" but of "failure to maintain HDHP coverage".

So once the what-would-have-been-excess-contributions-but-aren't has been added to Other Income and the penalty calculated on form 8889, then you are done.