Excess HSA Contribution distribution from previous year

[slinde]

I applied for survivor Social Security benefits in March 2022.  I am over 65, employed, and receiving full medical benefits under an HDHP.  When I was approved for Survivor benefits in June 2022, I was automatically enrolled in Medicare Part A back to September 2021, thus making my September thru December 2021 HSA contributions excess contributions, along with all of my 2022 contributions. 

I stopped my HSA contributions in July 2022.  I requested and received a distribution of excess HSA contributions for 2021 from September thru December, and another excess distribution for 2022 (January thru July).  I received two 1099-SA’s for 2022 – one for normal medical distributions and one for the combined 2021/2022 excess contributions distributions. 

I have not been able to determine how/where to enter the 2021 excess contributions distribution as income for 2022.  Is there a penalty due for the 2021 contributions that became excess contributions when, in June 2021, I was retroactively enrolled in Medicare Part A back to September 2021?  Do I need to file a corrected 2021 return?

[BillM223]

So when you did your 2021 return in early 2022, did TurboTax not tell you about the excess contributions? I am trying to understand what actually happened.

"When I was approved for Survivor benefits in June 2022, I was automatically enrolled in Medicare Part A back to September 2021," - yes, when you start Social Security. you are required to start Medicare if you are 65.

"thus making my September thru December 2021 HSA contributions excess contributions, along with all of my 2022 contributions. " Yes, the 6 months of backdating catches nearly every taxpayer by surprise.

"I stopped my HSA contributions in July 2022." - So, are you saying that you reported the excess contributions for 2021 in July 2022?

"I requested and received a distribution of excess HSA contributions for 2021 from September thru December, and another excess distribution for 2022 (January thru July)." - So you asked for the return of the excess for 2021 and 2022 separately?

"I received two 1099-SA’s for 2022 – one for normal medical distributions" - may I assume that you received a separate "normal" 1099-SA for medical expenses for 2021?

"and one for the combined 2021/2022 excess contributions distributions. " - You mean you received only 1 1099-SA with a distribution code of '2'? (box 3).

"I have not been able to determine how/where to enter the 2021 excess contributions distribution as income for 2022." - You have a problem here. You are not permitted to withdraw excess HSA contributions after the due date of the return. The HSA custodian should have asked you if you had filed for an extension when you asked to withdraw the 2021 excess; if you had not, then they should NOT have sent you the excess. This means that not only is the one 1099-SA that you received for the excesses not valid (they should not be together) but you should not have received a 1099-SA for the excess withdrawal for 2021anyway.

If you had received a valid 1099-SA for the 2021 excess, it would have been entered on the 2021 return, but I can't advise you to just file an amended return, because the HSA custodian made a mistake, and at this point will be very reluctant to fix it.

"Is there a penalty due for the 2021 contributions that became excess contributions when, in June 2021, I was retroactively enrolled in Medicare Part A back to September 2021? " - There is a penalty if you make excess contributions in a year and then do not fix the issue by the due date of the return. If this happens, then the excess is "rolled over" to the next year, with a 6% extra excise tax. However, at this point, it is too late to withdraw the 2021 excess without penalty.

Do I need to file a corrected 2021 return?" - I am going to have to ask you a lot of questions first.

#1. What was the amount of the excess for 2021?

#2. When did you file your return in 2022 for 2021?

#3. What was the amount of the excess for 2022?

#4  Have you filed your 2022 return yet (I suppose not)?

[slinde]

“So when you did your 2021 return in early 2022, did TurboTax not tell you about the excess contributions? I am trying to understand what actually happened.” – I did not have an excess contribution for 2021 at the end of 2021.  The excess contribution for 2021 occurred in June 2022 when I was approved for the Social Security survivor benefit and was retroactively enrolled in Medicare Part A back to September 2021 (6 months prior to my initial request for benefits in March 2022).

“#1. What was the amount of the excess for 2021?” – I stopped my 2022 HSA contributions in July 2022.  I requested a distribution of my 2021 HSA contributions from September thru December 2021 ($1462).  I also requested a distribution of my 2022 HSA contributions from January 2022 thru July 2022 ($2625).  My HSA custodian supplied a “Request to Return Excess Contribution Form”.  I returned 2 copies of the form, as directed by the custodian – one for 2021 excess contributions of $1462, and one for 2022 excess contributions of $2625.  I received two 1099-SA’s for 2022 – one for $527.12 code 1 (normal distribution of medical expenses), and one for $4087 code 2, the total of the 2021 and 2022 excess contribution distributions.

“#2. When did you file your return in 2022 for 2021?” – I filed my 2021 tax return in April 2022.

“#3. What was the amount of the excess for 2022? – $2625

“#4 Have you filed your 2022 return yet (I suppose not)?” –  No, I have not.

Since I posted this question, I reread and reared other questions and replies similar to mine.  I now understand that I should have requested a normal distribution of my 2021 “excess” contributions.  That would have included the 2021 distribution ($1462) in the code 1 (normal) 1099‑SA for 2022 and omitted it from the code 2 (excess) 1099-SA for 2022.  Everything would have been fine.  I would pay a 6% excise tax on the 2021 amount $1462 since it remained in the HSA account on December 31, 2021.

I called my HSA custodian today to ask if they could file corrected 1099-SA’s, and they said no, they cannot.   Is this true, or are they trying to avoid making a correction?  Was the error totally on my part, or did the custodian error by making the 2021 distribution in 2022 as an “excess” distribution?  I am planning to file for an extension.  I have made a copy of my return in TurboTax and “massaged” the 1099-SA numbers to reflect what should have been done.  So, I can fairly accurately estimate my tax liability.  What are my options to “correct” this in order to make a final 2022 filing?

Thank you very much for your assistance!

[BillM223 · Accepted solution]

"Is this true, or are they trying to avoid making a correction?" - Even if the HSA custodian is allowed to do this, they are notoriously reluctant to make changes after the due date of the return. Even though the fact that they placed excess contributions for two tax years on the same 1099-SA was an error on their part, they are very unlikely to correct it. This means that you just have to do the best you can in case anyone ever asks about what happened.

If you are going to do things right, you will want to do this:

1. Amend your 2021 return. You will note that you have excess contributions but do NOT say that you will withdraw the excess. TurboTax will add the excess to Other Income (correct), and TurboTax will carry over the excess to 2022, creating a 6% excise on the rollover. 

2. Figure out the numbers as best you can that should have been on the 1099-SA withdrawing your excess contributions for 2021. Place the excess amount (for 2021) in box 1, and '1' in box 3. This will be made-up because you don't have and will never have the actual 1099-SA. We are going to treat this amount not as excess contributions but as a distribution not for medical expenses. This amount will be added to Other Income and will be dinged 20%, but it will cut off any ongoing carryover of the excess.

3. On your 2022 return, you will show excess HSA contributions. Withdraw the excess if you can. 

Now you are going to have to do some independent thinking. I don't know how much you have in cash in your HSA (possibly none). Once there are no dollars left in your HSA, there is no longer an excise penalty on the rollover of excess contributions from previous years. This is because the 6% penalty is actually 6% of the smaller of the amount in your HSA on December 31 or the rollover amount. 

Obviously, once you have reduced the dollars in your HSA to zero, your excise tax (penalty) also goes to zero, and since you will never again be able to contribute to your HSA, the penalty will never again be greater than zero. So your independent project is to take your actual numbers and calculate when your HSA goes to zero. Once that happens, you have no incentive to fix the excess rollover problem. This could happen as soon as your 2022 tax return - I think you should amend your 2021 tax return in any case.

If you think about it, anyone who starts Medicare with an excess carryover will eventually face this situation. To my knowledge, the IRS has not addressed this situation of rollovers that generate $0 penalties, but you shouldn't pay what you don't owe.

[slinde]

I think there may be confusion regarding how I have referred to the distributions.  I will try again to describe them for clarification.  In July 2022, I received 2 separate distribution checks:  (1) a distribution of $1462 of excess contributions from 2021, and (2) a distribution of $2625 of excess contributions made in 2022.  The request for these distributions were made via two separate “Request to Return Excess Contribution Forms” – one for the 2021 excess contributions and one for the 2022 excess contributions.  I don’t know if this additional explanation changes your recommendation.

“1. Amend your 2021 return. You will note that you have excess contributions but do NOT say that you will withdraw the excess. TurboTax will add the excess to Other Income (correct), and TurboTax will carry over the excess to 2022, creating a 6% excise on the rollover. “I understand this.

“2. Figure out the numbers as best you can that should have been on the 1099-SA withdrawing your excess contributions for 2021. Place the excess amount (for 2021) in box 1, and '1' in box 3. This will be made-up because you don't have and will never have the actual 1099-SA. We are going to treat this amount not as excess contributions but as a distribution not for medical expenses. This amount will be added to Other Income and will be dinged 20%, but it will cut off any ongoing carryover of the excess.”  This I don’t understand, since I did not receive the distribution in 2021.  This “2021” distribution was received in July 2022.  Does not the “creation” of a 2021 1099-SA in the amended return throw up flags to the IRS?  Also, since I am over 65, am I not exempt from the 20% penalty?

“3. On your 2022 return, you will show excess HSA contributions. Withdraw the excess if you can.”  This I don’t understand either.  I already withdrew this amount in July 2022. 

You have suggested that I makeup a 2021 1099-SA for filing an amended 2021 return.  What about modifying the 2022 1099-SA’s to reflect the “2021” distribution as part of the “normal” distribution and removing it from the “excess” distribution?  Will that throw up flags to the IRS?

I still have a significant amount in my HSA (have been healthy, so far).

Yes, I will need to amend the 2021 tax return since I owe the 6% excise tax on the excess contribution that “retroactively” existed of December 31, 2021.

Again, thank you very much for your advice.

[BillM223 · Accepted solution]

"Withdraw the excess if you can." - I said this because I had no idea how much you had left in your HSA, what with all the dollars you had been withdrawing. I am happy that your HSA is still flush.

"Does not the “creation” of a 2021 1099-SA in the amended return throw up flags to the IRS?" - As it turns out, the 1099-SA has been identical from year to year for more than a decade. Since all the IRS sees are the numbers in the boxes, they won't have any way of knowing that the form was for a different year (it was different in the old days when we still filed on paper).

In any case, yes, the IRS gets copies of forms that are sent to you, so I would expect that there would be a dissonance in what the IRS gets. But that's OK, because there was no way to avoid it because of what the HSA custodian did (allowed a withdrawal for 2021 excess contribution after the 2021 due date). So you will in any case have to document everything that you have done and why, in case anyone ever asks.

"Also, since I am over 65, am I not exempt from the 20% penalty?" - Other things being equal, this is true. However, what I was trying to do is cut off the 6% carryover year after year (which, again, I did not know would apply to you because if your HSA ran out of cash, it wouldn't).

And I missed your birthday party so your current age was not on the top of my mind. 

In any case, we don't want TurboTax to calculate that 6% a year every year on your once cash-flush HSA.

To be fair, the IRS has never addressed the situation of a taxpayer going on Medicare with a carryover rolling over year after year. Because you are on Medicare, you can never be eligible to contribute to your HSA again. So the normal way of eliminating the rollover can't happen. 

Why don't you go ahead and enter this pseudo-1099-SA. I think you are correct that TurboTax will not add the 20% penalty, yet will cut off the rollover, so you won't have to worry about what the IRS may or may not say later when they get around to thinking about this issue.

Have I covered everything?

[slinde]

Yes, I believe you have answered my questions and given me confidence in going forward with my tax returns.

I will invite you to my next birthday party.  😊

Thank you VERY much for your assistance!