HSA excess contribution in 2022 corrected in 2023

[jperasso]

My wife contributed the full amount to her HSA for 2022. After realizing she would not meet the requirement for the full year in 2022 she withdrew half of it in 2023 prior to the tax filing deadline (she will qualify for 6 months contributions in 2022). Should we report this correction on our 2022 return or will it be done on our 2023 return? If we need to do it on the 2022 return, where is it done?

Thanks!

[BillM223 · Accepted solution]

When your spouse withdrew the money from her HSA, did she tell the HSA custodian that this was for the "withdrawal of excess contributions"? If not, then the HSA custodian will have their paperwork wrong.

Furthermore, the custodian will send her a 1099-SA with a distribution code of '1' instead of '2'. which means that when the 1099-SA arrives and you enter it into your 2023 return, it will cause you to be penalized.

If this is the situation, you need to have your spouse contact the HSA custodian and ask them to consider this "withdrawal" to be a Mistaken Distribution. If HSA custodian accepts this (be nice, because they don't don't have to), then she will sign a form, and then she will write a check for that amount and send it to them.

Then, do the following:

1. Do enough of your 2022 return in TurboTax to see what TurboTax thinks the excess amount is - we discourage taxpayers from estimating what the excess is because they often get it wrong.

2. As soon as TurboTax determines that there is an excess, TurboTax will add this amount to Other Income if the contributions were through her employer (code W in box 12 on her W-2). You need do nothing else about making this amount taxable.

3. Then contact the HSA custodian and ask for the withdrawal of this amount as "excess contributions".

4. Then in late 2023 or early 2024, the custodian will send her a 1099-SA with a distribution code of '2'. Box 1 will include the amount of the excess plus any amount of earnings made on the excess since they were incorrectly in the HSA. Box 2 will contain the earnings alone. The earnings will be added to your 2023 return.

5. The custodian will send you a check for the amount in box 1.

The "correction" is done on your 2022 and 2023 returns, as described above. Please let TurboTax handle the corrections for you.

[jperasso]

Thanks for the thorough answer.

The HSA funds were withdrawn as excess contributions, and included the attributable earnings.  This was done with the HSA custodian through a form specific for withdrawing excess (the custodian is Fidelity). They sent her a letter confirming the exact amount to be withdrawn as excess - and it is all done now.

Turbo Tax is not recognizing the excess. It is actually not excess until my wife does not have an HDHP for all 12 months the following year (we anticipate this). But Turbo Tax doesn't ask if she will meet the one year test so it assumes that it is not excess.

The bulk of contributions in 2022 and all of the excess was made as a direct contribution, not from the employer, so it is now in TurboTax as a (substantial) deduction from our taxable income.

She will only qualify for six months in 2022, so the excess withdrawn was $3,650 plus $46.30 attributable earnings. Originally she had contributed up to the family limit for the full 2022 year.

So not sure what to do. Will it all come out in the wash on 2023 return after I get proper forms from Fidelity HSA?

Thanks,

Jacob

[BillM223]

"Turbo Tax is not recognizing the excess." - Are you saying that your spouse had coverage on December 1, 2021? This invokes the last-month rule, as I guess you know. 

However, TurboTax has not way of knowing if your spouse will be able to "maintain HDHP coverage" through all of 2023 - and it would be inappropriate for TurboTax to ask, because you the taxpayer can't be sure either.

I assumed from your first post that your spouse did NOT have HDHP coverage on December 1; it was not until you made the second post, that I realized that she did utilize the last-month rule. So much of my first response is inappropriate, because I was misled.

OK, if I understand it now, your spouse in fact did not have excess contributions in 2022. Instead, your spouse will fail to maintain HDHP coverage in 2023 - this is quite different. What will happen is that TurboTax will ask you questions on your 2023 return in 2024 that will show that your spouse did not maintain HDHP coverage in 2023, and TurboTax will go through a separate process to determine how much you should have been able to contribute assuming that you did not use the last-month rule.

Then TurboTax will calculate how much income to add to your 2023 return and also assess a 10% additional penalty.

NOW we have another problem - you withdrew a lot of money as excess contributions when you should not have. (Failure to maintain HDHP coverage is NOT the same as excess contributions).

If you can, by tomorrow (April 18, 2023), contact your HSA custodian and ask then to treat your recent withdrawal of "excess" contributions as a mistaken distribution. (there may be a form on the custodian's website for this). Note that the HSA custodian is likely to refuse to do this after April 18, 2023. You will need to sign something as well as send the custodian a check for the total distribution. Note that the custodian does not have to accept this request so be nice.

Then NEXT YEAR (i.e., in early 2024 on your 2023 tax return), TurboTax will take care of this.

If you added any income or made any adjustments to your 2022 return for this situation, please undo them before you file. Your 2023 tax return will take care of this situation.

[jperasso]

Hi. So the reason we withdrew the funds from the HSA is to avoid paying the 10 percent penalty on the contribution. Are you saying there is no way to avoid the 10 percent penalty? Are you saying that we need to redeposit the withdrawal back into the HSA tomorrow by asking them to treat it as a mistake? (The funds have never left their bank so it would be a transfer back into the HSA account.) What if we can't get this done? It took a few weeks to process the withdrawal so I'm doubtful it can be put back in a day.

[jperasso]

So the HSA custodian has agreed for us to return the mistaken distribution and we should be able to get the funds back into the HSA in the next few days. They said it doesn't matter if it processes after the April 18 tax deadline. We have filed for an extension on our taxes so we will take our time and get it right.

My understanding is that we will have to pay the 10 percent penalty on 2023 taxes assuming we don't qualify for the year test.

Thanks for your help. Please let us know if there is anything else we should do.

[BillM223]

"So the HSA custodian has agreed for us to return the mistaken distribution and we should be able to get the funds back into the HSA in the next few days. They said it doesn't matter if it processes after the April 18 tax deadline. We have filed for an extension on our taxes so we will take our time and get it right."

All good.

"My understanding is that we will have to pay the 10 percent penalty on 2023 taxes assuming we don't qualify for the year test."

If your spouse "fails to maintain HDHP coverage" in 2023 (as you expect to happen), then TurboTax will take you through a convoluted calculation to figure out what you should have been able to contribute if you had not used the last month rule. I say "convoluted" because sometimes there is no correction at all.

But you can be sure that there will be a 10% penalty on top of whatever TurboTax calculates. This will appear in Part III of the 8889 on the 2023 return. 

[jperasso]

"But you can be sure that there will be a 10% penalty on top of whatever TurboTax calculates."

Please explain. Are you saying that Turbo Tax will not calculate the penalty?

[RalphH1]

The TurboTax program will handle everything regarding this “last month rule” situation. It will put the income on line 20 of Form 8889 (flowing through to line 8f of Schedule 1, and then line 8 of your 1040). And it will put the 10% penalty on line 21 of the 8889 (flowing to line 17d of Schedule 2, and line 23 of your 1040). Unless they change the line numbers next year, of course...

@jperasso, Bill was handling this all quite adeptly, but it appears he’s not here today (so I thought I’d jump in). Let us know if you have any more questions about this!

[jperasso]

After a week of back and forth the HSA custodian says they cannot process the mistaken distribution. Their final answer is that they do not do this for withdrawals of excess contributions - only for wrong medical medical payments.  The representative I spoke to April 18 was misinformed. I fear to understand the full consequences now.

To note, we spent about $2000 on qualifying medical expenses in 2022 that we didn't withdraw funds from the HSA for. It will be a similar number in 2023 probably. I'm guessing this can't be applied now but just wanted to check.

At any rate is there anything else to do on my 2022 return regarding this?