HSA excess contribution

[RMartIndiana]

My daughter had an HSA beginning December 2021 when her employer's health plan changed to an HDHP.

She funded her HSA in the first few months of 2022 in the amount of $3540, which is less than the full year limit.

However, she left this employer in April 2022 and began working for a different employer that did not have an HDHP, so the HSA contribution limit is prorated to only 4 of 12 months.

During her time with the employer with the HDHP, she used all the funds in her HSA including some contributed in 2021. So, by the time she left the employer, her HSA balance was zero.

Now, her balance is zero but the HSA had been over-funded compared to the prorated limit.

As such, TT is calculating a penalty (which appears to be 20% or more of the overfunded amount) and advising that she withdraw the excess funds before April 18th (to avoid an additional 6% penalty). Well, those funds were already used and the balance is zero (and was before the end of tax year 2022).

So, my question, should she select the option in TT that says she will withdraw the full excess balance by April 18th (because it was actually already fully distributed in 2022)? If so, what amount is taxed and what penalty is applied?
Specifically, the excess contribution in 2022 was $2323. Also, apparently an additional $200 (of $500 contributed in Dec 2021) is treated as income from 2021 due to the 'last month rule' since her HSA that began in December 2021 didn't exist through all of 2022.

Thank you.

[BillM223]

The good news is that we can get rid of the 6% penalty, but we need to fill our form 8889 correctly. We need to ask some questions first:

1. How much did she contribute to her her HSA for 2021? And for 2022? Did she contribute anything in 2022 for 2021?

2. Did she have Self-only HDHP coverage in Jan 2022? How about in 2021?

3. When did she stop the HDHP coverage in April 2022? Was it after April 1st? (It makes a big difference).

4. On her 2021 return, did TurboTax tell her that she had excess contributions? If so, were they withdrawn by April 15, 2022?

[RMartIndiana]

Thank you for the reply.

1. How much did she contribute to her her HSA for 2021? And for 2022? Did she contribute anything in 2022 for 2021?
$500

2. Did she have Self-only HDHP coverage in Jan 2022? How about in 2021?
Yes to both (only Dec 2021 and then Jan - Apr 2022).

3. When did she stop the HDHP coverage in April 2022? Was it after April 1st? (It makes a big difference).
Late in April (3rd week or so)

4. On her 2021 return, did TurboTax tell her that she had excess contributions? If so, were they withdrawn by April 15, 2022?
I don't believe there was any indication of excess contributions in 2021 in TT.  Yes, all HSA funds (from 2021 / 2022) were withdrawn by 4/15/22.

[BillM223]

1. How much did she contribute to her her HSA for 2021? And for 2022? Did she contribute anything in 2022 for 2021?
$500 - In which year and for which year?

2. Did she have Self-only HDHP coverage in Jan 2022? How about in 2021?
Yes to both (only Dec 2021 and then Jan - Apr 2022).

On what date in December did her HDHP coverage begin (it makes a big difference, again)?

Yes, all HSA funds (from 2021 / 2022) were withdrawn by 4/15/22.

By, "withdrawn", you mean "distributed" or "spent", right? "Withdrawn" refers to dollars that were taken out because they should not have been there in the first place (not your situation). Sorry, it's taxspeak.

The good news is that you will not owe any penalty for the excess HSA contributions in 2022, because the penalty is 6% of the SMALLER of the amount to carryover to 2023 or the amount in your HSA on December 31, 2022 (which, in your case, is zero). So, 6% of zero is zero.

But do answer the  questions about so we can wrap this up.

[RMartIndiana]

1 - The $500 was an employer contribution toward a full year of coverage... so I guess technically it was for Dec 2021 through Nov 2022. She no longer has access to documentation to confirm the dates of coverage of the HDHP or HSA contributions. But, her W2 from 2021 included the $500 employer contribution for sure.

2 - She believes it was effective December 1st 2021 but again isn't covered under this plan any longer and doesn't have documentation. Is the start date still relevant since the $500 from her employer was for more than just December 2021.

3 - Yes, distributed through normal distributions as indicated on her 1099-SA for 2022.

Am I correct that she won't have to pay the 6% penalty since all is withdrawn and I should select the option in TT that says all funds will be removed by April 18th?
Also, am I correct that she will pay 20% (for taxes not previously paid) on the excess amount applied in 2022?
Last, should the cost for December 2021 be eliminated somehow since the $500 was not all for Dec 2021? If so, how do I accomplish that in TT Deluxe when it automatically calculates it?

Thank you again!

[BillM223]

"1 - The $500 was an employer contribution toward a full year of coverage... so I guess technically it was for Dec 2021 through Nov 2022. "

I don't know what "full year of coverage" refers to. She is covered by her HDHP plan. Her HSA is an account (similar in some ways to an IRA) that she can use to help pay for qualified medical expenses not covered by her insurance.

So, her employer's contribution was not towards HDHP coverage, but towards her HSA, with a separate annual limit. HSA contributions are always limited on a calendar year basis.

"2 - She believes it was effective December 1st 2021 but again isn't covered under this plan any longer and doesn't have documentation. Is the start date still relevant since the $500 from her employer was for more than just December 2021."

The start date is absolutely relevant, because the coverage that you have on the first day of the month is the coverage you have for the month.

We will assume that it was effective December 1st because the employer made a contribution which the employer assumed was valid (it would not have been valid for 2021 had the start date been after December 1st).

If the employer made a mistake on the effective data of the insurance, then the employer should not have made the contribution. If the employer in this case would not have made the contribution (or would have withdrawn it in time), she would not have been subject to the penalty of the last-month rule (if you use the last-month rule in any given December to maximize your annual HSA contribution limit, you must stay under HDHP coverage for the next year). But all of this is dependent on the date on which her insurance was active.

"should select the option in TT that says all funds will be removed by April 18th?" No. This is when the difference between "withdrawn" and "distributed" becomes important. If you actually have excess HSA contributions, then you have the option to withdraw those excess contributions as excess contributions without penalty by the due date of the return. But distributing those dollars as medical expenses is not the same thing and doesn't count as a proper withdrawal.

Because there are no dollars left in the HSA, you cannot withdraw the excess contributions, so you must answer "no".

"Also, am I correct that she will pay 20% (for taxes not previously paid) on the excess amount applied in 2022?" 20% is the penalty she would pay if she took money out of the HSA to spend on something other than qualified medical expense. That hasn't happened here. If you think it has, please explain.

"Last, should the cost for December 2021 be eliminated somehow since the $500 was not all for Dec 2021?" What does "cost" mean here? Why do you say that the $500 was not all for Dec 2021? The $500 was for the HSA as part of the annual HSA contribution limit. I don't understand what you are saying here.

[RMartIndiana]

Let me try to provide better responses to your questions and/or clarify what I meant.

1 - The $500 was a benefit from the employer and was the only HSA contribution they were going to make during the year of coverage under the new HDHP plan. Any other HSA contributions by payroll deduction were by employee choice. So, what I meant below was this this was their contribution to the HSA for the year of HDHP coverage.

2 - She believes coverage under the HDHP plan began Dec 1st 2021 and I agree with your assumption that the employer contributed to the HSA in December based on this start date, as well.

By "cost" in reference to December 2021 per the last-month rule, I meant the additional tax and/or penalty that TT is calculating for an excess contribution in December 2021 for one month HDHP coverage in 2021. Also, I meant that the $500 from the employer was the HSA contribution / benefit for the entire upcoming coverage year under the HDHP which extended into 2022 (not just Dec 2021)

I'm a little confused now on what I should choose to enter in TT for 2022 and what the resulting taxes/penalties will be both for 2022 and 2021 (Dec). 
If I select "NO" as you've indicated regarding withdrawing excess contributions, won't this result in the 6% penalty?

For 2021, TT is saying $200 of the $500 is considered "income" for the last-month rule. I assume this is because the entire contribution was made by the employer in December even though HDHP didn't begin until December and then because her coverage under an HDHP ended in April when she switched employers (so she wasn't under an HDHP for all of 2022). Is it correct that she is being 'penalized' in this way because of the timing of the contribution and I should just leave all inputs in TT as they are?

Thank you!

[BillM223 · Accepted solution]

"If I select "NO" as you've indicated regarding withdrawing excess contributions, won't this result in the 6% penalty?"

Yes, but as I pointed out above, the carryover penalty is 6% of the SMALLER of the carryover or the amount in the HSA at the end of the year, Since the amount in her HSA at the end of the year (I assume) was zero, 6% of zero is zero...so no penalty.

"Is it correct that she is being 'penalized' in this way because of the timing of the contribution and I should just leave all inputs in TT as they are?"

The effect of the last-month rule is to allow you the full annual HSA contribution limit, no matter how few months you had the HDHP insurance. So her employer could have contributed $500 (as it did) or $1,000 or the maximum of $3,600, all in December.

The "only" problem with the last-month rule is that you (well, your daughter) has to stay under HDHP coverage for the next year. If she does not (as she did not), then TurboTax has to ask you a lot of questions (which I guess you have seen) to recalculate what the annual HSA limit would have been if there were no last-month rule, and then use that to figure the amount of the excess HSA contribution.

In this case, she would have been allowed for one month an annual HSA contribution of $300 (1/12 times $3,600), so the $500 contribution would have been a $300 HSA contribution and a $200 excess contribution (which, yes, you add to income and pay tax on).

So, because I am not sure what you have entered, I would say, leave everything as it is but make sure that you don't tell TurboTax that you will withdraw the excess contribution for 2022 by April 18th, because you can't withdraw money that isn't there.

So, yes, she will pay tax for "failure to maintain HDHP coverage" - see line 18 on form 8889, but she should not pay a penalty for the carryover of the excess to 2023 - see line 49 on form 5329.

[Mike9241]

she was only eligible for 1 month of coverage in 2021 or $300 because she did not remain covered by a HDHP through 12/31/2022. That's $200 of income + a 10% penalty

did you enter the 1099-SA? the taxable earnings are in box 2?

the $2323 excess contribution is income for 2022

the earnings on the excess contribution is income for 2022

there is also a 20% penalty on the income related to the excess contribution

so income for 2022 $200 excess for 2021 + $2323 excess for 2022 + earnings on excess contributions from box 2 of 1099-SA (schedule 1 line 8f)

penalties 10% on $200 overcontribution for 2021 + 20% on earnings on excess contribution. these are flat rate penalties not based on the value of the account

the 5329 should show $0 penalties because the value of the a/c was zero on 12/31/2022

[Jules5080]

I am also having issues with Turbo Tax telling me that I have excess contributions - I have double checked everything that was mentioned in a previous post. No carryover from 2021 - I deleted the W2 and re-uploaded. Answered the questions again - 3 W3's covered all year (each covered self).  One contribution is $3650 and other individual is $1700 + 1946.10=3646.10. I am at wits end.  Neither of them on Medicare.

Julie 

[BillM223]

So you are filing Married Joint, right? And both of you are covered by a Self-only HDHP plan (perhaps from two separate jobs)? And your W-2s are each assigned to the right taxpayer (it's easy to miss the button which assigns the W-2)?

And in the HSA interview, on the screen "Let's enter [name]'s HSA contributions", you did not enter on the second line any amount that was already in the first line (i.e., on your W-2)? This is a common way to accidentally tell TurboTax that you made excess contributions.

What was the amount of the excess contributions, and who made them? The taxpayer with the $3,650 or the other? And how were the contributions made? Through the employer (so on the W-2 in box 12 with a code of W), or directly to the HSA custodian?