HSA excess contributions

[sanjay-acharya]

I need help in understanding how HSA excess contributions are handled. Here is my situation. In 2022, I and my wife made an excess contribution to HSA. We removed excess contribution (from my account) before 2023 Apr tax deadline but realized later that we still have $300 in excess. I had the $300 excess contribution further removed from my HSA account around Sep 2023. Now fast forward 2023 tax filing, we made the exact $7750 contributions limits in total for 2023. Now while filing the 2023 return, here are the steps I followed,

a. Page "Let's enter Sanjay's HSA contributions"

    Excess HSA contributions carryover from 2022 still in HSA account - 0

    Any contributions you personally made - My actual 2023 contributions

b. Who made the excess HSA contribution? Sanjay (Not sure why TT asks me this question when there is no excess contribution in 2023)

c. Enter Last Year's (2022)  Excess Contribution - $300

d. Next page is "You may want to withdraw money from your HSAs" with 3 options given.

     (i) OK, we will make/have made the full $300 excess contribution withdrawal by April 15, 2024.

     (ii) We will make/have made some of the excess contribution withdrawal by April 15, 2024.

     (iii) No, we're not going to make this withdrawal.

1. Why is TT considering $300 excess contribution for 2023 even though we made exact contributions (total) as per limits?

2. Was the $300 excess 2022 contribution that got rolled over in 2023, considered contributions for 2023 too?

3. Should I withdraw $300 before Apr 2024 tax deadline and indicate the same in TT (for tax year 2023). But this will in reality reduce our 2023 HSA contributions by $300. 

4. I assume any HSA  distributions (for excess withdrawal) will be indicated in 1099-SA form and will need to be filed with TT and taxed. But correct me if I am wrong. 

Appreciate any help with this.  

[sanjay-acharya]

Just a further note. If I reduce my HSA 2023 contributions by $300  in TT, then It does not complain about excess 2023 contribution in $300 which makes sense to me as I withdrew this amount in Sep 2023 (due to excess contribution in 2022). But this would make my 2023 HSA contributions not match the value in the 5498-SA form provided by the institution (less by $300). But need an expert to give their opinion.

[BillM223]

1. Why is TT considering $300 excess contribution for 2023 even though we made exact contributions (total) as per limits?

Because, as you suspect, the $300 from 2022 was carried over to 2023, so you inadvertently made excess contributions in 2023, too.

2. Was the $300 excess 2022 contribution that got rolled over in 2023, considered contributions for 2023 too?

Yes. Up until a couple of weeks ago, it was invisibly put on line 2 of the 8889 (the IRS does not give any instructions and where to report the carryover). TurboTax has done this for years. However, the IRS cleverly changed the error checking at e-file to reject a return in the cases where Line 13 (8889) was not the smaller of Line 2 and line 12. So TurboTax had to do a hurry-up change, and now the carryover prints on line 2 (or is added to your personal contribution and printed).

3. Should I withdraw $300 before Apr 2024 tax deadline and indicate the same in TT (for tax year 2023). But this will in reality reduce our 2023 HSA contributions by $300. 

If TurboTax will let you withdraw the $300, then do so. Yes, of course, it reduces your contribution for 2023.

4. I assume any HSA  distributions (for excess withdrawal) will be indicated in 1099-SA form and will need to be filed with TT and taxed. But correct me if I am wrong. 

Yes, the withdrawals will be reported on a 1099-SA (separate from the 1099-SA for your regular medical expenditures). But, no, only the earnings on the 1099-SA will be taxed. This is because the moment that TurboTax found that you had excess HSA contributions, if the contributions were through your employer (i.e., with code W in box 12 on your W-2), then the excess was added back to other Income, or if you made the HSA contributions directly to the HSA custodian (it sounds like you did), then the amount of the contribution on line 13 (form 8889) is reduced by the amount of the excess.

Please do not try to make any manual adjustments for taxing the excess - TurboTax will do all this automatically.

If I reduce my HSA 2023 contributions by $300  in TT, then It does not complain about excess 2023 contribution in $300

This is what you should do, because the carryforward of excess contributions can be erased by (1) making space for the carryover to be used up in the subsequent, or (2) making a distribution for non-medical purposes, which is declared as income and hit with a 20% penalty (obviously, #1 is highly preferable).

I am concerned about your September withdrawal, because the withdrawal of the excess if supposed to happen by the due date. Did you have a form 5329 on your 2022 return? Or perhaps did you not file until October 15, 2023?

Please let me know, so that I can address this.

[sanjay-acharya]

Thanks Bill. Only part of the withdrawal was done before Apr 15, 2023. The remaining $300 was done in Sep 2023 and that was taxed at 6% in last year's return. I tried one more thing in this year's return. Let me know if this looks good.

Page: Let's enter Sanjay's HSA contributions

        Excess HSA contributions carryover from 2022 still in HSA account: <300>

* Any contributions you personally made    : <3050> 

(not through your employer)

Note: (TT pulled above value automatically from 2022

Page: Who made the excess HSA contribution?

      <Me>

Page: Enter Last Year's Excess Contribution

      <$300>

Page: You may want to withdraw money from your HSAs

      It looks like Sanjay has an excess contribution of $300. This amount is being taxed an extra 6%.

      Selected <OK, we will make/have made the full $300 excess contribution withdrawal by April 15, 2024.>

Now after the above step, the correct amount of $3050 is shown as deduction for me. Note that $300 had already been removed in Sep of last year.

Now in my Form 5329 the following is shown,

42 Enter the excess contributions from line 48 of your 2022 Form 5329. If zero, go to line 47.      <300>

43 If the contributions to your HSAs for 2023 are less than the maximum

   allowable contribution, see instructions. Otherwise, enter -0-  <300>

44 2023 distributions from your HSAs from Form 8889, line 16    <0>

45 Add lines 43 and 44.  <300>

46 Prior year excess contributions. Subtract line 45 from line 42. If zero or less, enter -0-     <0>

47 Excess contributions for 2023 (see instructions)   <blank>

48 Total excess contributions. Add lines 46 and 47.  <0>

49 Additional tax.  <0>

[BillM223]

As you can see, the $300 withdrawn in September 2023, continued to be carried over and dinged 6% because it was not withdrawn by April 15th, 2023. But that's OK, because the numbers you give in your last response show that you contributed $300 less than the max in 2023 (i.e., $300 less than the maximum annual HSA contribution limit), so this allowed the $300 carryover to be used as a "personal" contribution in 2024. That is, the carryover has been "used up" and completed.

See that line 48 on the 5329 is zero, meaning that you had no excess for 2023, and the excess from 2022 was used up, so you are done with carryovers.

This looks like the optimal outcome.