HSA

[parkjk2]

I had a prior year excess contribution to my HSA resulting in a taxable amount.  In the past filing year, 2020, I had qualified medical expenses that resulted in distributions from the HSA (I have a1099-SA) that reduced entirely the excess contribution and would have eliminated the tax burden.  The TuboTax software did not seem to take into consideration the distribution, only asking what my year-end HSA value amount was.  It did not address the distribution at all, as far as I know, and I ended up filing a return with the HSA excess contribution taxable income still there.  The software did not seem to catch this scenario.  Now I need to amend my return, I think, and to get clarification from Intuit's seeming error from Intuit, I need to pay an addition $100 or so dollars.  Do I have a misunderstanding of how HSA works and TurboTax is correct?  Or, does it seem like TurboTax software missed this and I have no recourse with Intuit without paying more?

[BillM223]

"Do I have a misunderstanding of how HSA works and TurboTax is correct?"

Yes, you do not understand how HSAs work, and TurboTax is correct. HSA rules are remarkably arcane and obscure for such a simple thing, and I find that HR people and even HSA custodians don't always understand them.

The definition of "excess HSA contributions" is simply that you contributed more to your HSA than was allowed by your HDHP coverage. The amount that was distributed during the year has no bearing on this, nor does it matter how much you have in the HSA at any given point.

TurboTax calculates your annual HSA contribution limit based on whether you had Family or Self-only HDHP coverage, how many months you had coverage, whether you had coverage on December 1, 2019, whether or not you had conflicting coverage (like Medicare or a spouse's FSA), and whether or not you were 55+.

If you contributed more than that amount for 2020, then you had excess contributions.

To repeat, excess contributions are not affected in any way by distributions.

More questions?

[parkjk2]

Hi BillM223.  Thank you so much for your reply!  However, my google research indicates that qualified medical expenses paid for via HSA distributions count toward eliminating the excess contribution made by my employer to the HSA years ago.  Otherwise, the same excess contribution would be taxable every single year.  In fact, the IRS form takes this into account and has a line-item for the distribution that would result in the elimination of the tax liability (in my case).  Unfortunately, the TuboTax software did not address any of these issues to take into account the elimination of the excess contribution via qualified medical expenses.  I had the same tax liability for the HSA as I did last year, which seems incorrect.

[BillM223]

Unfortunately, either what you read was wrong or you misunderstood it.

What you may be thinking of is that if you take a distribution for nonqualified medical expenses. you will (1) have to report that amount as income, (2) pay a 20% penalty on top of that, but an amount of the excess carried over from a previous year equal to the nonqualified distribution will be forgiven, well, discharged.

Note that you can withdraw excess contributions up until the due date of the return, so 2020 excess contributions can be withdrawn until May 17th (October 15th if you file an extension).

Once that date has passed, you can no longer withdraw this excess. So for an excess from 2019 or before, you must discharge it either by applying it against a future HSA contribution limit if you are eligible to contribute or by taking a distribution for non-qualified medical expenses.

Please show me the link to what you are reading, and I'll explain it to you.

P.S. "Otherwise, the same excess contribution would be taxable every single year. " - in fact, this is the way it works unless you either discharge the excess in a future year or make a nonqualified distribution...or your HSA runs out of money (then the excess is still carried over but the penalty is reduced to zero).

[parkjk2]

I really appreciate all your help!  Below is the link to one of the articles I read on the subject, the last section being the pertinent part (I believe).  

Removing HSA Excess Contributions — Ascensus

There was another article I read last year that specifically mentioned taking a distribution from the HSA for QUALIFIED medical expenses was one of the ways to correct an excess contribution in a prior year.  I can no longer find the article so I'm suspecting the information was wrong and the article deleted.  I will keep searching.  It was not hard to find earlier so it was from a reputable source.

By way of some background, a prior employer (only) contributed to my HD HSA account.  I no longer work for that employer.  In my 2018 tax year, I realized via turbotax my HSA account balance was above the allowable limit.  I paid the 6% tax on the excess contribution.  The excess stayed in my HSA account--no further contributions and no distributions.  In 2019 tax year, I realized the same excess was being taxed 6% again.  I did not know this would happen.  I researched as mentioned above and found an article indicating that the excess would need to be removed from my HSA to avoid the perpetual tax penalty.  One of the ways it said to do so was take a distribution and use it for qualified medical expenses.  If I used the distribution for UN-qualified medical expenses, I'd have to pay 20% tax on the amount distribution.  I spent my HSA distribution on qualified expenses during the 2020 tax year and received a 1099-SA for the distribution amount--which was greater than the amount of the excess contribution.  I thought this would thus eliminate my tax liability for the excess contribution since it had been 'removed.'  Unfortunately, after filing my taxes today using turbotax, I see that the same excess contribution amount was taxed again and that going through the turbotax software did not take into consideration the distribution I used for qualified medical expenses.  And that's where I am now, trying to figure out what I did wrong or if there is a hole in the turbotax algorithm, and if I need to file an amended return.  Thank you again for all your gracious assistance! 

[BillM223]

First, the author of that Ascensus piece says that she is a "QKA" and a "CIP". A QKA is a certified 401(k) plan administrator. A CIP is a Charter Insurance Professional. The CIP has little or nothing to do with tax. A QKA is good for running a qualified retirement plan - but an HSA is neither insurance nor a retirement plan.

This is probably why she writes things like "IRS guidance is unclear, but it appears that HSA owners who" and "The rules for dealing with HSA excess contributions and their reporting are likely to be less familiar to custodian and trustee organizations than the IRA excess contribution rules, but the principles are sufficiently similar." In other words, to some extent, she is relying of the similarity of IRAs and HSAs to give advice.

Indeed, HSAs and IRAs are to some extent similar - but that's as far as it goes. For example, in some cases a non-deductible IRA contribution can still be contributed to an IRA, it just isn't deductible. (i.e. creates "cost" or "basis" in the IRA). For HSAs, there is no such thing - either the contribution is deductible or it's not, and if not, it's in excess.

Please note that her article was not aimed at taxpayers, but at people who have "HSA clients" (i.e., employers and consultants like herself). So careful reading is called for.

I do not see anywhere where she says that a distribution for qualified medical expenses would cure (eliminate) the excess carried over from a previous year. The closest she comes is "IRS guidance is unclear, but it appears that HSA owners who remove excess contributions after their tax filing deadlines and do not use them for qualified medical expenses  may also be subject to the additional 20 percent penalty tax (unless an exception applies)." The previous sentence about distribution not for qualified medical expenses is simply saying that any distribution not for qualified medical expenses - whether to cure a prior year excess or not - is taxable in the year you receive it.

However, on page 1 of the form 8889 instructions, it is abundantly clear that the taxpayer will be hit with a 20% penalty - the IRS says, "However, any part of a distribution not used to pay qualified medical expenses is includible in gross income and is subject to an additional 20% tax unless an exception applies." The exceptions are for things like you became disabled or died or turned 65.

In any case, I do not see that she alleges that a distribution for qualified medical expenses would cure a prior year excess. Let me know if you find that other link.

[parkjk2]

You are correct.  The article I linked above does not specifically mention using distributions for qualified med expenses as a way to remove excess contributions.  That advice was specifically mentioned in another article that I can no longer find.  I combined it with information from the article above (and other articles) to conclude my HSA strategy for the 2020 tax year that has not turned out as planned.  As mentioned earlier, since I can no longer find the specific article in question, I suspect you are correct and the information provided was wrong, and therefore, the article deleted.

Anyway, if I may indulge in your generosity further, I'd love to get your thoughts on where I should go from here.  To recap: Per my 2018 filing, I had an excess HSA contribution of $1700.  I paid the 6% tax penalty that year.  The next year 2019 filing, I realized I was being taxed on the same $1700 again.  I researched what I needed to do to avoid the tax liability on the $1700 and implemented it during the 2020 tax year.  I had HSA distributions for qualified medical expenses throughout 2020 totaling $2120 dollars thinking it would eliminate the excess contribution and resultant tax liability.  I fill out my 2020 taxes using turbotax yesterday, and the software only asked what the value of my HSA was at the end of 2020 which was $2120 less than it was the year before and below the HSA allowable limit.  The software asks no other questions on the issue.  I efile.  Only then, of course, do I see I was showing the same $1700 as an excess contribution amount and taxed 6% on that amount again.  Please note there has been no additional contributions to the HSA since 2018 from any source.  The value has only gone down by the $2120 distribution I used for QME.  I received a 1099-SA from the HSA for that amount.

Did the software handle my HSA correctly?  Did I mischaracterize the $2120 distribution in my filing?  The software did not address that amount at all and is not listed anywhere in my tax filing.  There was no IRS form 8889 produced by the turbotax software in my tax filing.  Are my taxes correct with regard to the HSA?  If not, I assume I need to amend?  And, finally, how do I remove the excess tax liability on what had previously been $1700 in excess HSA contributions?  Again, I already used $2120 from the HSA for QME in year 2020.  It seems I was taxed for an amount ($1700) that is no longer there.

As always, thank you so much!!!  You're kind assistance has been invaluable.

[BillM223]

"the software only asked what the value of my HSA was at the end of 2020" - the software asks this because it is calculating your penalty for carrying over excess contributions. The penalty is 6% (0.06) of the smaller of total excess contribution's being carried over or the value of your HSAs on December 31 of the tax year. When your HSA drops to zero funds, then the penalty will be zero, because 6% of zero is zero.

The $1,700 is still there. It's not necessarily in your HSA anymore, but since you have not cured the excess, it is virtually still there. As I noted above, there are only two ways to get rid of the carryover after the due date of the return for the year in which you incurred the original excess:

1. Apply the excess to a subsequent year's HSA contribution limit, or
2. Make a distribution for NON-qualified medical expenses.

So tell me the following:

The original excess was generated for the 2018 tax year, right?

In 2019 and 2020, did you have HDHP coverage? If so, 

   A. what kind of HDHP coverage did you have in 2019 and 2020?

   B. What were the amounts you contributed to your HSA in 2019 and 2020 (if any)?

   C. Is your HSA now empty?

"There was no IRS form 8889 produced by the turbotax software in my tax filing." - I take this to mean that you did not make any contributions to your HSA in 2020. How about in 2019?

As before, place @ BILLM223 (without the space in between) at the bottom of your reply so that I will be notified of your response.

[parkjk2]

Hi Bill!

The original excess was generated for the 2018 tax year, right?

Correct.  In filling out my taxes for the 2018 tax year, it was determined that I was over the allowable contribution amount by $1700.  I paid the 6% penalty that year.  The next tax year, I realized the $1700 excess carried over and I paid 6% penalty on that same $1700 again.  I was determined to avoid the penalty on my 2020 tax year and, as mentioned above, took a distribution of $2100 during the year that I applied to Qualified Medical Expenses.  While filling out my taxes for 2020, the software asked for the total value of the HSA at the end of 2020 which by that time was $2100 less than it was the year before.  I thought that meant I was under the excess contribution limit.  Nevertheless, I was still assessed 6% tax liability on the $1700.  The software did not address the situation further.  I'm gathering now from discussing with you, that the QME distribution in 2020, even though greater than the amount of the excess contribution, and even though it resulted in my HSA balance being under the allowable limit, was not effective in curing the $1700 excess contribution penalty.  

A. what kind of HDHP coverage did you have in 2019 and 2020?

I had none.

B. What were the amounts you contributed to your HSA in 2019 and 2020 (if any)?

Zero

C. Is your HSA now empty?

No.  I have a balance but it is at least $1700 less (by $2100 to be exact) than the maximum allowable as calculated on my 2018 and 2019 taxes.  

I take this to mean that you did not make any contributions to your HSA in 2020. How about in 2019?

Correct--only distributions for QME of $2100.  I guess my only option now is to make a distribution for NON-qualified medical expenses, as you mentioned, since applying the excess to a subsequent year's HSA doesn't seem to fit my circumstances.  There is no excess to apply.  I already reduced my HSA by the excess amount; I just applied it incorrectly if I'm understanding you correctly (?).

Thank you so much @BillM223  !!!!

Greatly appreciated as always.

[BillM223]

"I'm gathering now from discussing with you, that the QME distribution in 2020, even though greater than the amount of the excess contribution, and even though it resulted in my HSA balance being under the allowable limit, was not effective in curing the $1700 excess contribution penalty.  "

Correct, it did not cure the excess that just keeps rolling over.

"since applying the excess to a subsequent year's HSA doesn't seem to fit my circumstances.  There is no excess to apply. "

There is still the excess, right? It's just that you have nothing to apply it to, since you are no longer eligible to contribute to an HSA.

"I guess my only option now is to make a distribution for NON-qualified medical expenses, as you mentioned,"

You have two options (sort of): (1) if the excess that has been carried over is MORE than the amount remaining in your HSA (I can't keep track of your current balance), then withdraw your entire HSA amount as for non-qualified medical expenses. You will pay income tax and penalty on that amount (but not the whole excess), and then your HSA balance goes to zero.

Once this happens, your 6% penalty also goes to zero and will stay that way.

(2) If the excess carried over is less than your balance in the HSA, withdraw the excess amount as non-qualified expenses, pay the income tax and the penalty, then be sure to use the rest of the HSA balance on real medical expenses. The withdrawal of the excess will will stop the excess from rolling over any more and no more 6%.

OK?