Last Month Rule Employer Contribution

[infamousdanno]

My employer's benefit year runs from December 1 to November 30 every year.  In 2018, they introduced an HDHP/HSA option.  I opted into this for a family plan.  My employer made a $1,000 contribution on December 1, but I did not start making my own contributions out of my paycheck until January 2019.

On December 1 of this year (2019), I will be switching to a non-HDHP option, which I understand would invalidate any last month rule contributions made.  My understanding is that will have been allowed to contribute $575 for December 2018 ($6,900/12) and $6,416 ($7,000/12 x 11 months) for January through November 2019.  Based on this, will I be facing a penalty because my employer's $1,000 contribution in December 2018 is greater than $575, and thus is subject to last month rule eligibility?  

Our HSA provider is telling me that my situation does NOT violate last month rule eligibility, but I'm not sure I understand why.  Does anyone have any insight?

[dmertz · Accepted solution]

Your HSA provider is correct.  No part of the $1,000 is an excess contribution because it was permitted under the last-month rule as a contribution for 2018.  However, because you will not complete the testing period for the last-month rule, you will be subject to a 10% ($43) extra tax on your 2019 tax return on the $425 you would not have been eligible to contribute for 2018 were it not for the last-month rule.  Because this $425 is NOT an excess contribution, it is not eligible to be returned as an excess contribution to avoid the extra tax on your 2019 tax return (and even if it was an excess contribution eligible to be returned, the deadline for doing so has passed).  You are simply subject to the extra tax on your 2019 tax return and that will be the end of it.  TurboTax handles reporting this extra tax.

[dmertz]

I made slight corrections to my answer.  Please reread it on the forum.

[infamousdanno]

Thanks! Just to clarify, am I understanding that “excess contribution” is a specific term which applies specifically to situations where you contribute more than the maximum, separate from the last month rule? If so, that wasn’t actually the terminology used by my HSA provider. They basically implied there would be no fees or extra taxes if I switch to a different insurance plan on December 1. Based on your response, I think my understanding, wrong terminology aside, seems like it’s in the right direction.  You confirmed the 10% applies to the amount over $575.  Do I also need to pay my marginal tax rate on the extra $425? Is that now considered income or does the fact the it’s an employer contribution make it be treated differently?

[dmertz]

I forgot to mention that the $425 is also subject to ordinary income tax on your 2019 tax return.  All contributions, including those made by your employer, are made on your behalf no matter who makes the deposit and are pre-tax money in the HSA, so they factor equally into figuring the consequences on the tax return for the year in which you failed to complete the last-month rule testing period.  In this case your employer excluded the $1,000 HSA contribution amount from boxes 1, 3 and 5 of your 2018 W-2, so the $425 needs to be taxed the same on your 2019 tax return as if you had made the contribution yourself for 2018 and had received a deduction for that contribution.

[BMcCalpin]

"...am I understanding that “excess contribution” is a specific term which applies specifically to situations where you contribute more than the maximum, separate from the last month rule? If so, that wasn’t actually the terminology used by my HSA provider. They basically implied there would be no fees or extra taxes if I switch to a different insurance plan on December 1. "

Your understanding is correct that failing the last month rule's "testing period" does not give rise to an "excess contribution", although it's easy to see why people might say that, since the calculation of the additional income in 2019 is calculating what the excess contribution would have been had you not applied the last-month rule in 2018. But see Section 223 (b)(8)(B) at https://www.law.cornell.edu/uscode/text/26/223 for the actual language; also see under the heading "Testing period" at https://www.irs.gov/publications/p969 , where the $425 is referred to as "income" and the 10% is referred to as "additional tax".

The statement that "there would be no fees or extra taxes if I switch to a different insurance plan on December 1" would have been true only if the date would have been after December 1st (like December 2nd) or if you switched to another HDHP policy.