HSA Excess Contribution Never Returned

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Hi,

I have quite a situation with HSA excess contributions. I overfunded my HSA in 2022 because I switched jobs mid-year and no longer had an HDHP.

I tried to resolve this issue last year before the 2022 filing deadline. I had submitted the form with my HSA provider to re-distribute my excess contributions and it looked like it had been accepted. However, after reviewing my account this year, I discovered that a stop payment was actually issued on this so the money never left my account.

It is my understanding that since the money was still in the account as of April 15, 2023, even though I filed the form requesting a distribution of the excess contribution, this is still considered an excess contribution and I am subject to all the penalties.

Here's where my questions come in.

1) I was under the impression that this was processed when I filed my 2022 return, but it appears it didn't get resolved. As such, I need to amend my 2022 return to include the excess contribution and pay the 6% excess tax (in addition to the income tax on the contribution which I've already paid). It seems that I should be filing a federal amended return, correct?

2) I made all the contributions in California, a state that taxes HSA contributions. Would I need to file an amended California return as well? It seems like I wouldn't need to since California already taxed that money as income, but I wasn't sure if California also applied a penalty. I only lived in California for part of the year, but I made no contributions in the other state. Would I need to amend the other state as well?

3) Since the money was still in my account in 2023, I owe 6% again for 2023. Is this 6% on the original excess contribution value or the excess contribution value plus interest?

4) I need to resolve the situation in 2024 to avoid future penalties. I plan to take an non qualified withdrawal this year, which is subject to the 20% tax plus 2024 income tax correct? Will I also need to pay the 6% excess contribution for 2024 since it was in my account for part of the year? It will also be considered income for state tax purposes for 2024, correct?

5) Do I just need to withdraw the original excess contribution amount or the excess contribution amount plus interest? Do I need to do anything special for the non qualified withdrawal to "count" for removing the excess contribution?

6) Aside from getting a new HSA, is there any way to avoid the 20% tax? Is it possible to transfer to an FSA?

Thanks!

[dmertz · Accepted solution]

1)  Correct, you need to file Form 5329 with Form 1040-X to report and pay the 6% penalty

2)  There is nothing to amend your California tax return.  I'm not aware of any state that has a separate penalty for excess HSA contributions.

3)  The 6% penalty for 2023 is only on the excess, not the interest.  In 2023 TurboTax, enter exactly the amount of the excess as the amount of your excess contribution carried in from 2022.

4)  The correction in 2024 is made by obtaining a taxable distribution (a distribution not claimed as used for medical expenses) of exactly the amount of the excess, no adjustment for investment gain or loss.  There will be no 6% penalty for 2024 but the distribution will be subject to ordinary federal income tax and, if you are under age 65, a 20% additional tax.  California does not tax any HSA distributions because California treats the HSA as if it was an ordinary savings account.  The taxable HSA distribution is subtracted from federal AGI on Schedule CA Section B line 8f column B.

5)  The taxable distribution should be equal to the amount of the excess contribution with no adjustment for investment gain or loss.

6)  The only way to avoid the 20% additional tax is to not take a taxable distribution before age 65.  The only way to correct this excess without taking a taxable distribution would be to again qualify to make an HSA contribution and apply the excess as part of the HSA contribution for that year.