2022 HSA Excess Contribution through Payroll Deduction that Has Been Withdrawn (plus earnings) from HSA Custodian

[HSAHelpNeeded]

Hello Turbo Tax Community!

Here's my HSA nightmare situation:

I retired on 12/31/21.  I received my last paycheck on 1/7/22.  On this 2022 paycheck, it showed a payroll deduction of $169.23 to the my HSA.  I contacted my previous employer immediately because I was no longer eligible to contribute to an HSA since I was not, nor would I be, enrolled in a HDHP in 2022.

My employer said not to worry...that those contributions were really for my last 2 weeks of 2021, not for 2022.  I told them that I had already contributed the maximum amount for 2021, and again, that I wasn't eligible to contribute to the HSA in 2022.  I asked them to reverse the contribution because I didn't want to deal with excess contributions on my 2022 tax return or have any IRS tax related issues, and I also explained that the IRS cares about the calendar year the contributions were made in, and that I am not eligible to contribute to an HSA in 2022.  Again, they said not to worry.

Frustrated, and not satisfied by my employers response, I reached out to Fidelity, the HSA Custodian, directly and explained the situation.  Fidelity said I was right and that my employer was wrong. I filled out the necessary paperwork, and I received a check withdrawing the excess contribution plus the earnings.  Fidelity said I would receive a 2022 1099-SA showing this withdrawal as an HSA distribution with reason code "2" for excess contributions.  Please note that the "earnings" were negative ($3.49) because of the market downturn during this time, so my withdrawal was $165.74, which was less than the contribution.

"Awesome!", I said.

I received the 1099-SA, as expected, and I thought I was all set.

Fast forward to now....

I received my employer W2, and the $169.23 was in box 12c with code "w". Got everything entered into the system, along with the 1099-SA, which I thought would "undo" the excess contribution when I did my taxes.

Unfortunately, It does not.  

If I answer all of the questions truthfully - i.e. were you eligible for an HSA?, I answer "no", and will I withdraw the excess before the deadline?, "yes",  How much? "$165.74"), it still reflects the 6% excise penalty of $10 on the $169.23.   

So, I did some searching, and I found an article at https://www.benstrat.com/hsa-faq-excess-contributions/#:~:text=To%20do%20so%2C%20you%20need,a%20corr.... that states the following:

"If you made the excess contribution through pre-tax payroll deduction, you need to work with your employer to ensure that your Form W-2, which your employer delivers to you by January 31 to help you complete your personal income tax return, reflects your contributions accurately. To do so, you need to correct the mistake before the end of the calendar year and notify your employer. If you remove your excess contribution after December 31 but before the due date of your personal income tax return (April 15 most years), you must notify your employer, who then will issue a corrected Form W-2."

I have now reached out to my employer, but I'm getting the same song and dance from them as I did when I initially raised the concern right after receiving my last paycheck on 1/7/22.  I provided them a copy of the 1099-SA, as well, as the letter I received from Fidelity accompanying the check of my returned contributions, so I could prove that this $169.23 was withdrawn.

I feel like I'm in the movie, "Groundhog Day", and I don't know how to proceed without a corrected W2 reflecting the removal of $169.23 from box 12c and adding that amount to wages in Box 1.

Any suggestions on how I should proceed?

Also, when Turbo Tax asked me to put in the amount of the withdrawn employer contributions, should I have entered $169.23 (the amount of the contribution) instead of $165.74 (the actual amount returned to me)?  Maybe that's where I'm running into the issue.

[BillM223 · Accepted solution]

1. You do not need or want a corrected W-2. 

2. "If you remove your excess contribution after December 31 but before the due date of your personal income tax return (April 15 most years), you must notify your employer, who then will issue a corrected Form W-2."" - This is simply wrong. 

3. Either your employer made a mistake in not stressing to the HSA custodian for which year the contribution was for, or the HSA custodian made a mistake in their paperwork on which year they marked the contribution for. The problem is that after January 1st, it's difficult to get either one of them to fix it.

4. However, you have the easiest fix:

A. enter the W-2 as is (with the code W amount)

B. Enter the HSA interview and enter the 1099-SA with code '1' if you have one

C. Enter the 1099-SA with the code of '2' on next year's return (yes, in 2024)

D. When TurboTax tells you that you have excess contribution, be agreeable and say that you will withdraw all of them before April 18th (the 169). Don't worry about the 165.

E. In this way, you will be done with this, except that in 2024 (for 2023), you will enter the 1099-SA with code '2' to report the earnings, and make sure that you indicate that you do not have HDHP coverage.

[HSAtaxproblems]

@Anonymous @Bradley_C @junglejordan : My employer switched to HSA Bank mid year, so my contributions got messed up and I over contributed. HSA Bank also told me they could not calculate excess earnings. TERRIBLE custodian. They have all the information to do that easily and yet they for some reason refuse so I have to do it by going through all my starting and ending balances from my statements. Isn't that a key part of their job as a custodian? Is there a way to make a complaint to the IRS about HSA Bank so that HSA Bank starts to actually do their job? 

[GLR2023]

I also made an excess contribution in 2022 via Payroll reduction, but only discovered the error after my 2022 Tax return is filed and finalized (already have the refund).  I've calculated earnings and submitted the reversal request to HSA bank and expect it to be processed before the filing deadline.

Is it now best to go ahead and file an amended return for 2023 prior to 18 April?   (I'd have to go off my calculations, rather than any corrected w-2 etc.

[RalphH1]

As long as you remove your excess HSA contribution by the deadline, there is no requirement to file the actual amendment (which will be a corrected 2022 return, as discussed here) by that date. Nor is there a need to wait for a revised 1099 (as long as you have the correct numbers for the excess itself. Note that the earnings will be taxable on next year’s 2023 return). Of course, penalties and interest on anything you might owe start at the deadline, so that could be considered a reason to file it as soon as possible.

And (just a heads-up) there usually is more tax to pay in this scenario. That’s because even though the excess being withdrawn precludes the extra penalty, the money came from your checks (or from your employer) without being taxed, and that benefit has to be undone now (since it’s in your possession and not in the tax-favored account).

@GLR2023, we normally like to provide guidance on the TurboTax entries (and this all goes in the “1099-SA, HSA, MSA” section in “Deductions & Credits”). But I can’t tell from what you wrote exactly how you reported it the first time around (or whether you left it out completely). Feel free to re-post with any specifics about that, or any questions that come up as you’re amending, and we can help some more!

[GLR2023]

Hi Ralph,  I appreciate your help, and went back to look at my tax return.  We filed two copies of Form 8889, one for me, and one from my spouse (married filing jointly).  In my form 8889 I entered $7.300 at line 3, and $1,000 at line 7.   Thinking I was high deductible for the entire year.  All of my HSA contributions were via payroll, pre-tax and exempt from FICA/Medicare.

Now when I correct our joint 2022, I wonder if this is the way to go.  Can you confirm or correct my thinking?

A. Don't change anything about W-2 income, it remains the same, because that's what my employer reported.

B. Get to the HSA part, and answer the questions differently to show I was not eligible (family HDCP the entire year but also has Medicare Part A, for the last five months.

C.  That should lead me to section of turbo tax I've not visited before, which will ask questions and recalculate, my  Form 8889.   

D.   Then the changes to Form 8889 will generate additional income, taxes, penalty, etc, which flows automatically into Schedule 1 and/or Schedule 2 then into the 1040-SR.  

Is this roughly the right way to think about it.   Don't mess around recalculating an imaginary corrected W-2, just focus on the HSA questions and let the software and forms do the work? 

Thank you,  George and Laura

[RobertB4444]

That should be all that you should need to do?

@GLR2023 

[GLR2023]

That did it, just modified the HSA section of amounts contributed and excess removed until all worked out,  Since this is a joint returm we went thru the sections a couple of times trying different allocations of whom to attribute the excess to, until finding the optimum (least additional tax due).  Figured out we need to remove from my account, and add to spouse's account to get the most favorable tax treatment.   Would have been VERY slow/difficult to figure this out using paper forms.  Thank you Turbo Tax!

[trkjjj]

My daughter just realized that her husband’s former employer (he left that job in June 2022) contributed $640 to an HSA account for him in 2022. His W2 shows the $640 in box 12 with code W. Apparently, they offered a HDHP with employer contributions, but he was on my daughter’s plan so never used the HDHP and didn’t know he had the HAS account. Neither spouse was in a HDHP in 2022. He didn’t get a 5498-SA or 1099-SA form, but that could be because the HSA bank doesn’t have his contact information. He is looking into getting access to the account and to request that the money be withdrawn, but not sure this can happen by April 18th. What happens if he is not able to withdraw the excess contribution before the April 18th deadline?

[GLR2023]

Someone who is more expert can correct me, but here is my understanding as an amateur.

If the excess is not removed by April 18th, it is possible that a 6% penalty will be imposed,  Adding $38 to the tax bill.  That 6% recures each year, so go ahead and remove it, even after April 18th.  

When I went through the Turbo Tax menu, there is a question "Will the excess be removed before April 18th?"   I answered yes, so don't know what would happen if answering no.  If you can get a message requesting removal of excess to the HSA bank before April 18th, maybe you can in good faith answer Yes, avoid the penalty this years, and hope the IRS forgives the penalty if the bank is slow and a few days late with the removal.

For the removal, if there are any gains or losses on the $640 investment, they also need to be removed.  I believe that in your particular case where all contributions need to be removed, that simply removing every last penny will satisfy the IRS regulations.  See special rule found in 26 CFR 1.408-11 copied below.  Note:  It says IRA in the code, but I believe these rules also apply to HSA's in the same way.

Special rule. If an IRA is established with a contribution and no other contributions, distributions or transfers are made to or from that IRA, then the subsequent distribution of the entire account balance of the IRA pursuant to section 408(d)(4) will satisfy the requirement of that Internal Revenue Code section that the return of a contribution be accompanied by the amount of net income attributable to the contribution.

someone with more expertise, please correct me if wrong.  Best wishes.

[BillM223 · Accepted solution]

"didn’t know he had the HSA account. " - He did not have an HSA if he did not sign the paperwork agreeing to open it. That is, an HSA is like (in many respects) an IRA - you don't have one until you sign an application and put money in it.

Of course, it's possible that he signed the application not knowing what it was because his employer told him to - I am saying this to stress that the HSA belongs to the individual and not to the employer.

[He didn't get a]"1099-SA form" - he would not have if he did not make any distributions from the HSA - which, since he didn't know that he had it, he would not have. So no surprise here.

"What happens if he is not able to withdraw the excess contribution before the April 18th deadline?" - Immediately file an extension (form 4868), this resets the April 18th deadline to October 16, 2023. Surely by then you can get the withdrawal done. See "You withdraw the excess contributions by the due date, including extensions, of your tax return for the year the contributions were made" on page 8 of Pub 969.

When he is doing his 2022 tax return, indicate that (1) he has an HSA, and (2) that he has no HDHP coverage. Yes, I know that he had an HDHP that he didn't know about, but if you have conflicting insurance coverage (like his wife's plan), then to the IRS, it's as if you did not have any HDHP coverage. So tell TurboTax in the HSA interview that he did not have HDHP coverage for any month in 2022. This will end up forcing all $640 of the contributions to be excess, and when asked, he will say that he will withdraw all of the excess by the due date of the return (including extensions). Yes, TurboTax may say only "April 18, 2023" but you can see that the real dropdead date is October 16, 2023 as you can see at the link above.

This action will add the excess to Other Income for your 2022 return, and eventually, the HSA custodian will send you a check for this amount.

Just make sure that you extend the return NOW, and then keep up with the bank get that excess back to you before October 16th. Ask for "withdrawal of excess contributions" - the HSA custodian likely has a form on their website for this. This will cut off any issue with the 6% penalty on the carryover. NOTE: even though the return is extended, you can file the return at any time - you don't have to wait until October.

Then you should get in late 2023 or early 2024 a 1099-SA reporting the withdrawal of the excess and any earnings. The dist code in box 3 will be '2'. NOTE: box 1 will have the amount of the excess plus the earnings, but because the dist code is '2', this amount is ignored. Instead, the amount in box 2 (the earnings) is added to Other Income. Note that you will have to say in the 2023 return that you have an HSA just so you can enter the 1099-SA.

Now you are done with the entire issue.

@GLR2023 

@trkjjj 

[trkjjj]

Bill, thanks for the detailed explanation, this really helps! I was thinking that since the check for the excess contribution from the custodian is received in 2023, that is the year it would be taxed. But you indicate that it will be added to Other Income for the 2022 return so the tax on that money will be paid in 2022 return and not in the 2023 return. Is this correct?

[BillM223]

No, the receiving of the check for the excess is not what triggers the taxability of the excess.

The moment that TurboTax realizes that you have an excess (and assuming that the HSA contributions were made through your employer), TurboTax adds it back immediately to your Other Income on your 2022 return. Thus this action is not tied to the receiving of the actual check.

So, yes, because the original contribution was paid through your employer in 2022, the excess is added back to Other Income in 2022, so that you can pay income tax on it then. You will pay tax on the earnings only in tax year 2023.