1099 SA Excess Contribution

[ktramo17]

Hello

In 2022, my wife overfunded her HSA by $703 and in 2022, 2023 and 2024, we paid 6% excise tax on the $703.  In tax year 2025, we distributed the $703 out of the HSA and received a 1099-SA which included the $703 in box 1 and box 3 has code 2 for excess contribution.  

The questionnaire wizard for the form does not make sense.  How do i enter this information for 2025 so that i do not pay excise tax on the $703? Also, is this distribution considered taxable income? If so, how do I enter the information so that it is taxable income but no excise tax being triggered? Note, that my wife is no longer covered under a high deductible health insurance plan as of 2023, 2024 and 2025.  She is not employed.  She still has an HSA.

[ktramo17]

I was in the phone with Turbotax for over 2 hours and no one had any idea on how to help me resolve this issue nor knew the answer.  Here are some facts and general conclusions I am drawing that I need help with vetting.  In 2022, I can see on my 1040 that the $703 excess was included as "Other Income" line 8 and I paid an additional 6% excise tax on the $703 for that year.  In 2023 and 2024, I only paid 6% excise tax on $703 since it wasn't withdrawn.

My approach for 2025 is as followed: In tax year 2025, I did work with the HSA provider and the $703 was distributed out of the account so my thinking in the following in terms of how to handle this and make the software work.  Form 8889 Part II line 14a and 14b will show the $703, form 5329 will no longer need to be included since the excess $703 was removed from the HSA via the 1099-SA and the $703 distribution is not included in "Other Income" for tax year 2025 because I paid incomes taxes on that amount back in 2022 as supported by my return.  Does this approach make sense?

[BillM223]

Enter the 1099-SA as you received it.

Yes, the Box 1 amount ($703) will be added to income, but for the last time. However, TurboTax sees this distribution and uses it to cut off the carryover without you having to do or enter anything special. 

Just enter the 1099-SA and the carryover of the excess contribution will be done with.

[ktramo17]

Bill thanks but the software isn't doing as you say and it is important to note the years this excess distribution is related to.  I paid income tax back in 2022 in the year in which the HSA was overfunded and a penalty (6% excise tax).  In 2025, i distributed the excess out of the HSA.  Do we agree that no excise tax would be owed as of 12/31/25 since there is no more excess? 

Back to the income tax part related to the distribution that occurred in 2025.  What doesn't make sense to me is why I would pay income tax in 2025 when the money was distributed when I already paid the income tax back in 2022, the year in which it was overfunded? I understand the concept of "additional tax" in the form of excise owed due to the money not being pulled out, that penalty is separate and district from income tax.  From an income tax perspective why would the distribution be taxed again in 2025?

[Opus 17]

Code 2 was incorrect, this could only be used if the excess was returned within the original deadline (April 15, 2023).  This should be code 1 (normal distribution).

To remove the excess contribution, this must be reported as a regular withdrawal that was not used for medical expenses.  That will subject it to income tax plus a 20% penalty, but it will remove the ongoing excess issue.  

As to why you have to pay tax again?  Because that's the rule.  All withdrawals that are not used for medical expenses are subject to income tax plus a penalty.  The fact that a withdrawal not used for income tax is the only way to clear an excess when you miss the intended deadline (April 15 of the next year) is unfortunate, but that's how the law is written.

The other solution would be to leave the excess in the account and keep paying 6% (instead of paying 22% plus 10%) until you re-enroll in an HDHP and are eligible to make new contributions again, or you spend the account down to zero. 

[ktramo17]

Opus17, thank you for the information.  I want to respectively push back here for a minute so please hear me out.

I just looked up Box 3 codes and "1" indicates a normal distribution.  Isn't the whole point of identifying the excess back in 2022 addressing the fact that the money should have never been in the HSA in the first place which therefore would mean that it doesn't matter whether or not the funds are used for medical or not.  I did pay income tax on the excess and a 6% excise tax penalty for the overage.  I continued to pay that 6% excise tax each year the funds are in the account.  

The below is directly from the IRS instructions for form 8889.  Nowhere under "Distributions From HSA" does it reference a 20% penalty relative to excess funds used for non medical.  The IRS knows the funds aren't for medical because they should have never been in the HSA in the first place, hence the excise tax penalty and also why form 1099-SA has a code specifically for excess contributions.  I think where we agree is that for 2025, there shouldn't be any excise tax since there is no longer excess (6% x zero = zero).  Where I am challenging you is why is this distribution subject to income tax again? The excess was pretax when it went through payroll back in 2022.  When i filed my 2022 taxes in 2023, I identified the excess in the HSA and that excess was subject to income tax in the return I filed in 2022.  Explain to me why I would pay income tax again on this distribution in 2025? Where is the authoritative guidance that supports your statement on the income tax? I believe I have ruled out the 20% penalty based on review on the IRS form 8889 and the definitions of the distribution codes.  

Distributions From an HSA

Distributions from an HSA used exclusively to pay qualified medical expenses of the account beneficiary, spouse, or dependents are excludable from gross income. (See theLine 15 instructions for information on medical expenses of dependents.) You can receive distributions from an HSA even if you are not currently eligible to have contributions made to the HSA. Any part of a distribution not used to pay qualified medical expenses is includible in gross income and is subject to an additional 20% tax unless an exception applies.

[Opus 17]

@ktramo17 

You have to look at the instructions and form 8889 and 5329 (part VII).

To remove an excess contribution after the normal deadline so it is no longer taxed, look at the calculation on lines 43-47 of form 5329.  The specifically references that withdrawals from the HSA that are reported on line 16 of form 8889 are removed from the excess contribution carry over.

Then line 16 of form 8889 is taxable distributions because they are more than your qualified medical expenses.  And of course, taxable distributions are added to schedule 1 line 8f with a 20% penalty on schedule 2.   

A withdrawal of excess from 2022, that is made is 2025, can't be coded as a "withdrawal of excess" under code 3, because the procedure for withdrawal of excess only applies if the withdrawal is made before the tax deadline (including extensions) for the year in which the excess contribution was made.  That would be April 15, 2023 or maybe October 15, 2023, but by 2025 it is much too late to use that procedure.  You can only make a regular withdrawal.  And the way to use that regular withdrawal to clear the penalty is to not use it for medical expenses, so it is reported on line 16 of form 8889, which flows to line 44 of form 5329.

[ktramo17]

@Opus 17 ok this is much cleared.  Appreciate the thoroughness from your end.  I visually see now how we are clearing out form 5329 so that there is no longer excise of 6%.  Additionally, with what you are saying, I now see by changing to "normal distribution", on 8889, the "excess" was showing up in line 14a AND 14b, but 14b should be zero because it states to include any excess contributions that were withdrawn by the due date, which I did not do.  I think where I was getting hung up on was the way in which the 1099-SA was done by Healthequity which was then creating the issue of no additional income tax being triggered nor the 20% since it was throwing the distribution in line 14b of 8889, which as stated was not withdrawn by the due date.   

THANK YOU!

Last question for you.  Do you think it matters that the IRS will get a 1099-SA that shows box 3 with code 2 excess contribution but for my return, when i entered 1099-SA, i changed box 3 to be "normal distribution"? That seems to be the only way to get the software to do what it needs to do from a form standpoint but then there is a general mismatch.  My gut says why would the IRS care in this case since i am remitting both income tax and the 20% penalty.  

[Opus 17]

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@ktramo17 wrote:

Last question for you.  Do you think it matters that the IRS will get a 1099-SA that shows box 3 with code 2 excess contribution but for my return, when i entered 1099-SA, i changed box 3 to be "normal distribution"? That seems to be the only way to get the software to do what it needs to do from a form standpoint but then there is a general mismatch.  My gut says why would the IRS care in this case since i am remitting both income tax and the 20% penalty.  

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I don't know about the IRS but at most you would get a letter asking for an explanation, and you can answer that with a letter explaining the situation.  If you want to be really thorough you could include copies of form 5498 showing the excess was in 2022, not 2025, which would support that code 3 was wrong.

I have a similar situation because I funded my HSA from an IRA this year and that should be a 1099-R with code 1, and I got one with code G (which is for a direct rollover to another IRA).  I had to change it to code 1 so that form 8889 would correctly show the HSA funding.  I'm surprised that big banks and big brokers don't know some of these rules.