HSA Excess Contributions Options

[MariaFarr09]

I made a pretty simple mistake in placing too much into my HSA this year. My husband has a family plan with our son and I have my own HSA through work. I come to realize that even though we have separate accounts and premiums, because we are married, we are limited to the $7200 threshold for the 2021 tax year, instead of $7200 for his plan and $3500 for mine. This is the first year we have overcontributed to our HSA's and we exceeded the limit by $2900. I decided to take the money from my individual plan account.

When I was filling out the forms to withdraw the excess amount, I noticed that option 1 is "Change tax year to: _____ (Contribution will count toward your yearly contribution maximum.)" The HSA company representative told me that I can in fact forward this to the next year. My question is how will this reflect in my taxes this year? Will the extra $2900 still show up as taxable income if I am forwarding it to my contribution limit for 2022? Currently, as I am doing my taxes on TurboTax, it comes up as taxable income because my initial plan was to withdraw the funds. Is there a specific form that would have to be filled out or do I have to get a corrected statement? Thank you so much for your help!

[DaveF1006]

It depends. Please view this Turbo Tax post written by HelenaC. There are two options to consider.

Contact your H.S.A. administrator. The IRS is lenient on fixing excess HSA contributions. They provide two options of correction: removal or future application. 

Option 1: The first removes the HSA contributions in the tax year and avoids a penalty – no harm, no foul. You may withdraw some or all of the excess contributions and not pay the excise tax on the amount withdrawn if you meet the following conditions.

1) You withdraw the excess contributions by the due date, including extensions, of your tax return for the year the contributions were made.
2) You withdraw any income earned on the withdrawn contributions and include the earnings in “Other income” on your tax return for the year you withdraw the contributions and earnings.

Option 2: Alternatively, you can use an excess contribution as your HSA contribution in a future year. You just let your excess contribution sit and then apply it later; the downside is there is a 6% per year penalty. The mechanism that allows this is the deduction, since next year you won’t actually deposit the contribution (it is already there), you will just deduct it on Form 8889 in 2022. 

: 

Option 3: If you don’t remove the excess contribution from your account, you must include it as taxable income for the year you made it and pay an annual 6% excise tax on the excess contribution and any associated earnings as long as the excess contribution is in your account.

In answer to your question, the $2900 will need to show up as taxable income but there will be an 6% excise tax charged for that this year if you decide to leave it in. 

To remove, Turbo Tax will alert you that you have an excess contribution and that you may want to consider withdrawing. Here if you indicate that you will withdraw the excess by April 18, then it will not be taxable. Make sure though that you do this by contacting your administrator. 

I hope this helps.

[ Edited 02/23/22| 07:48 PM PST]

@MariaFarr09 

[whodiini]

There are 2 types of questions you are asking:  1) What is the right thing to do taxwise and 2) How to enter the information in turbotax.   DaveF1006 correctly answers topic #1.  Topic #2 is challenging.   I havent been able to figure how to do this in turbotax because the way that turbotax calculates the excess contributions may not match your $2900.  Then it doesnt allow you to enter $2900 as the amount of excess contributions removed.  If you are lucky, and the $2900 matches, then just follow the interview questions under HSA. 

[MariaFarr09]

Yes, I agree, the answer above is partially helpful. From a tax perspective, if its a 6% excise tax versus the tax in my current bracket, it might be worth rolling it over. When I asked the HSA rep he thought rolling it over was the best option too. But how do you report this in Turbo tax? Is this the 8889 form? If I make this distinction with my HSA institution, how to I report this in turbotax this year? Shouldn't it either tax the $2900 as additional income or tax the 6% without the additional income tax because it is not being withdrawn and acknowledged as extra income? Or is this an incorrect line of thinking?

[MariaFarr09]

Also, as I play around with the forms, if I say I will withdraw it, it taxes me on the 2900. If I say I am not going to, it taxes me an additional 6% on top of that... if I am keeping it in the HSA account, shouldn't it ONLY be the 6% penalty, NOT taxed as income and with the penalty? Or is that something that has to be sorted out with the 8889 the next year? How can they tax it as income AND excise tax if it is applied to the next year? Kind of sucks because if I had realized this earlier I would have put the money in my 403b and would be much better off on my return!

[BillM223]

It's not clear to me your situation, but please note the following.

1. Contributions made through your employer (i.e., the code W amount in box 12 on your W-2) is removed from Wages in boxes 1, 3, and 5. NOTE: this is called the "employer" contribution and includes BOTH what the employer contributed AND what you contributed through payroll deduction.

2. For this reason, the moment employer contributions are determined to be in excess by TurboTax, the excess amount is added to Other Income on Schedule 1 (1040). This is true whether you withdraw the excess or carry it over to next year. You are not allowed to keep the tax benefit of the excess contributions (i.e., the part of removed from Box 1 and therefore removed from your income) in any case.

3. Withdrawing the excess by the due date of the return (including extensions) in effect undoes the contribution. The addition of the excess is not a punishment for the excess, it is simply not letting you get a tax benefit for the amount of the excess that was removed form Wages in boxes 1, 3, and 5 on your W-2.

4. If you choose to carry over the excess to the next year, the amount REMAINS in your HSA to be spent. However, this reduces your annual HSA contribution limit for the next year (this is not at all clear from the 8889). So, in essence, it's as if it is contributed to your HSA next year, and you pay on 6% for this fudge. However, because of this reduction in the annual HSA contribution limit, you MUST reduce your planned HSA contributions for that next year. If you were planning to contribute the full amount you think you are entitled to next year, you must reduce your contributions by the amount of the carry over in order to not generate another excess contribution situation next year.

5. "But how do you report this in Turbo tax? " (referring to the "rollover")

When TurboTax tells you that you have an excess, then tell TurboTax that you are not going to withdraw the excess. TurboTax will say that it will be taxed (this year, on form 5329) 6%. If you use TurboTax next year, it will pace this amount in the Carryover Worksheet, so that TurboTax knows to reduce your annual HSA contribution limit next year.

And while we don't normally refer you to other websites that we don't own, you might read this article by The Motley Fool (this is a serious website, despite the name) which describes HSAs as superior to 401(k)s (and by extension (403(b)s ). Qualified plans like 401s and HSAs have their strengths and disadvantages, but the fact that contributions that you make to an HSA are tax-free, and the money you take out for medical expenses at any point in the future (contributions plus the earnings!) are also tax-free. There is virtually no other tax program that escapes taxation on the way in and on the way out.

It's just important to know the rules.

@MariaFarr09