HSA Excess Contribution and penalty

[weigeljl]

I am self-employed and had a HDHP Family plan until August 2020. While covered by that plan, I contributed $6000 to our HSA. Over the summer my spouse got a job with family health insurance, and we closed out the HSA for the entire amount of $13,600 (including the $6000 contributed but not yet deducted on our taxes) in the second half of 2020. My 1099-SA shows the entire $13,600 in box 1 and Normal Distribution in box 3. It seems to me that I should be able to withdraw the $6000 contribution (plus earnings) for 2020 without penalty and only pay the penalty on the funds in from prior years. Is that true? And how would I do that in Turbotax Desktop?

[Mike9241]

you evidently didn't know you can maintain an HSA even after you have non-eligible coverage. you just can't contribute any additional funds starting with the month you had non-eligible coverage.  so say your under 55, had family coverage until August when the non-eligible family coverage started, So for 2020 you could have contributed $7100*7/12  or $4,142. since you put in $6,000 $2,958 had to be withdrawn (non-taxable and penalty free)  + earnings that would be taxed.  you say you closed out the account.  did you have qualifying medical expenses of about $7600+$4142. (line 15 of form 8889)  if so, there should be no penalty.  if not, there's a 20% penalty on withdrawals not used for eligible medical expenses. 

review form 8889. 

[weigeljl]

Thanks for the answer. You're right, I didn't know that I could maintain the account, and fully acknowledge that it wasn't handled properly. As to how to handle now though, since I added the $6000 in 2020 and never got a tax deduction for it, shouldn't I be able to take it out before filing my taxes without penalty? I do acknolwedge that there will be a penalty on the funds that truly were pre-tax, i.e., the $7000 that were in the account at the beginning of the year.

[BillM223 · Accepted solution]

Unfortunately, an HSA is not a savings account that you can freely put money into and take money out of. There have to be specific circumstances by which you can withdraw contributions that you made.

As Mie suggested above, you did not have a full annual HSA contribution limit. On what date were you covered by your spouse's employer provided health plan? I ask because the first day of the month is what determines your insurance coverage for the month.

So, if you had HDHP coverage on August 1st and you went on your wife's policy on August 2nd, then you were still considered to be under HDHP coverage for the month. If this is the case for you, then you would have 8 months of coverage.

Mike's formula is correct for 7 months, giving you a tentative limit of $4,142 for 2020. TurboTax should have told you that you had excess contributions of $1,858 ($4,142 - $6,000) - you could contact the HSA custodian and ask to withdraw the excess plus its earnings (they will figure out the earnings).

However, if I read you right, there is nothing left in the HSA because you withdrew it all. 

You need to have a long talk with your HSA custodian. The fact is that your $13,600 distribution was a mistake. The IRS says in the Instructions for the 1099-SA:

"HSA mistaken distributions.

If amounts were distributed during the year from an HSA because of a mistake of fact due to reasonable cause, the account beneficiary may repay the mistaken distribution no later than April 15 following the first year the account beneficiary knew or should have known the distribution was a mistake. For example, the account beneficiary reasonably, but mistakenly, believed that an expense was a qualified medical expense and was reimbursed for that expense from the HSA. The account beneficiary then repays the mistaken distribution to the HSA."

Note the following TIP in the Instructions:

"As the trustee or custodian, you do not have to allow beneficiaries to return a mistaken distribution to the HSA. However, if you do allow the return of the mistaken distribution, you may rely on the account beneficiary's statement that the distribution was in fact a mistake. See Notice 2004-50, 2004-33 I.R.B. 196, Q/A-76, available at IRS.gov/irb/2004-33_IRB/ar08.html. Do not report the mistaken distribution on Form 1099-SA. Correct any filed Form 1099-SA with the IRS and the account beneficiary as soon as you become aware of the error."

So, the HSA custodian does not have to allow the return of the distribution, but if they do (and you do this before April 15th!), then this will happen:

1. You will send them a check for the entire 1099-SA (mistaken distribution)

2. You will fill out whatever form they want you to fill out

3. The HSA custodian will send you a corrected 1099-SA (if they have already sent you one for the 13,600)

4. You will not owe the $13,600 as income nor the 20% penalty

So you really want to do this, and if this requires groveling to the HSA custodian, then go for it.

So, if we undo the Mistaken Distribution, the money will be back in the HSA (which they will have to agree to reopen), so you can withdraw the $1,858 (they will send you a check for that), TurboTax will add it to Line 8 (Other Income) on Schedule 1 (1040), and all the rest of the money will still be in your HSA. After this, you will not be able to contribute to the HSA, but you can continue to take money out as needed for qualified medical expenses, until the HSA's funds are exhausted.

This is a highly desirable alternative, so read what I have written, read the Instructions for the 1099-SA, get the money together to pay back the mistaken distribution (even if you have to do short-term borrowing - it's cheaper than the 20% penalty), prepare yourself to persuade the HSA custodian that they do this (it will involve several steps for them)...and good luck!

Questions?

[weigeljl]

Thank you so much for taking the time to write that thorough reply. That sounds like an excellent option and groveling because of my error seems like a small price to pay. I will give it a shot and cross my fingers. Thanks again. Your giving me a way to approach it made my day regardless of what the custodian does.