Excess HSA contributions carryover

[lighter1]

1 year ago, while filing taxes for 2023 I put more than allowed into my HSA. At the time of working with TurboTax last year, I was asked if I want to withdraw the excess or have the excess be taxed, I elected it to be taxed and as I understand TurboTax, while filing my taxes, took that into account and withdrew corresponding amount of money to IRS to cover those taxes on the excess HSA contributions. While doing that I assumed I'm sort of "done" with that excess and I can forget about it.

This year, while filing taxes for 2024, the Turbo Tax's wizard is presenting a form where one of the fields is "Excess HSA contributions carryover from 2023 still in HSA account" contains a value of 1,500 with the following note: "Note: the amount here is carried over from your 2023 return, adjust or enter the actual remaining prior year excess contribution still in your HSA account.".

Few questions:

a) Why that amount is carried over if I already paid taxes for it last year? Given I already paid taxes for it last year I didn't expect to see anything this year about the fact that I overcontributed the previous year. Am I now  sort of "labeled" forever because one year I made an excess contribution and now I have to carry that burden indefinitely ?

b) Can you please help me understand that text in the note I highlighted in bold above? Based on what I should adjust that amount of 1,500 ? Just in case want to say that I did spent more than 1500 from my HSA this year.

[dmertz · Accepted solution]

a) The penalty for an excess HSA contribution applies every year until the excess is corrected by either removing the excess or applying the excess as part of your eligible HSA contribution for a subsequent year.

b) The instruction in bold is for those who did not transfer in a 2023 TurboTax file to begin their 2024 tax return, perhaps because they did not use TurboTax for their 2023 tax return or for those who corrected the excess before the due date, including extensions, but after filing and used their original 2023 tax file instead of their amended 2023 tax file to begin their 2024 tax return.

If you are ineligible to apply the $1,500 as an HSA contribution for 2024, the excess remains for 2024 and your penalty is 6% of the lesser of either the excess or your balance in HSAs.  Assuming that your HSA balance is above $1,500, that means a penalty of $90 for 2024.  To remove the excess now in 2025 you must obtain an ordinary distribution of $1,500 and make it taxable by not applying it to medical expenses.  If you are under age 65, this distribution will also be subject to a 20% additional tax.  As you can see, the consequences of not correcting an excess HSA contribution timely can be rather severe.

[lighter1]

Thank you so much @dmertz ,

In 2024, me and my spouse, combined, contributed into our corresponding (me into my and my spouse into the spouse's HSA) HSAs less than max allowed:

I did $5,500

My spouse did $1,600 

So the total is $7,100 which is less than $8,300 allowed for a married couple in 2024.

If I understand your response correctly, it seems like my total contributions in 2024 are not only the above calculated $7,100 we contributed in 2024 but also additional $1,500 carried from the previous year of 2023. So the total is $8,600 which means my total excess in 2024 is $300, correct?

Perhaps that is why Turbotax, at one of the last steps related to our HSAs displayed a message indicating that I have $300 of Excess Contribution and it presented 3 options:

1. OK, we'll withdraw the full $300 excess contribution by April 15, 2025
2. We'll withdraw some of the excess contribution by April 15, 2025
3. NO, we're not going to make this withdrawal

The options #1 and #2 are not really options because below them there was a note "Unfortunately, all of your excess contribution is caused by a prior year excess contribution. It is too late to remove any of this excess contribution."

So the only my option is #3 for which TurboTax hints: "OK. Just so you know, this amount will be taxed an extra 6%."

It looks like the above experience I have in TurboTax is exactly what you explained.

If I understand correctly, there is no way for me to avoid the 6% penalty on the excess of $300 now - while filing for 2024. But if I want to eliminate that when I will be filing for 2025, I need to "remove" those $300 so it is not considered as an Excess Contribution when I file taxes for 2025, in 1 year from now. Can you please share how I can achieve the highlighted in bold

"... obtain an ordinary distribution of $1,500 and make it taxable by not applying it to medical expenses ..."

?

I didn't highlight the $1,500, because, per the information I provided above, that amount is now $300.

Do I need to issue some special request to my employer or the company managing my HSA?

[dmertz]

If you are still an eligible individual, you can apply the remining $300 as part of your 2025 HSA contribution.  Doing so avoids the double taxation and 20% additional tax on the $300 and eliminates the 6% excess-contribution penalty for 2025.  Otherwise, to eliminate the penalty for 2025 you would have to take an ordinary distribution from the HSA and make it taxable by not applying it to medical expenses.

"Do I need to issue some special request to my employer or the company managing my HSA?"

The only thing that you might need to do is, if you are an eligible individual for 2025 and HSA contributions are being taken from your pay, make sure that your HSA contributions via your employer are not so much that you would not be able to apply the $300 as part of your 2025 contribution.  If you will be an eligible individual all of 2025 and new contributions for 2025 will be similar to those in 2024, it seems that you are already set up to have the space to apply the $300 to 2025.

[John hates taxes]

So I am in the same situation, had HDHP I overfunded in 2023 by $2640 but I didn't have a  HDHP in 2024. Now what do I need to do?

[BillM223]

You have to ask yourself, "is it likely that I will have HDHP coverage in the near future?" Because every year that you do not do anything about the carryover, you will be dinged 6% of the lessor of the carryover amount OR the value in your HSA at the end of the year. 

As you can see, it is 6% of the carryover amount or 6% of what is left in your HSA (which, if the HSA goes to zero, the penalty will go to zero).

If you have a lot of money in the HSA and want to stop the 6% per year bleed, then to stop the carryover for good, you do the following.

1. Take a distribution of the excess (i.e., call the HSA custodian and ask for them to send you some money).

2. When you get the 1099-SA, enter it into TurboTax and say that it is NOT for medical expenses.

3. This will add the excess to Other Income, and you will be penalized 20% in addition BUT at least the carryover will be gone.

So, as you can see this stop the carryover process is expensive, so you need to count on your fingers to decide which path is best for you.

@John hates taxes