Question on HSA Overfunding

[brian-perrigino]

Hi all, doing taxes for my daughter (M) & son-in-law (J)

- M had a high-deductible self-only health plan for all of 2022. Ms employer contributed $3650 to HSA.   

- J had a high-deductible self-only plan for January & February and then converted to family in March when their son was born.  Js employer contributed $7200 to HSA.   M was not added to Js health plan.

- Turbo Tax is telling me that the max is $7300 and that they've overfunded by $3550.  I assume that this is correct right, even though they had separate plans?  

- Also, TT says to avoid the 6% penalty, the $3550 should be withdrawn by April 18.  How do you do that?  Does a regular claim for a medical expense count, or do you somehow need to contact the bank and request money?

Thanks.

[BillM223]

That is correct; their annual HSA contribution limit is $7,300, because they are both considered to be under a Family plan, never mind that one spouse also had a Self-only plan.

So, yes, if they contributed to one HSA, then they will need to contact the HSA custodian and ask to "Withdraw excess contributions" (this keeps the paperwork at the custodian correct). For many custodians, there will be a form on their website to do this; otherwise just call them. If they spread their contributions over two HSAs, then they can withdraw the excess from either HSA so line as no HSA got more than $7,300.

"Does a regular claim for a medical expense count, or do you somehow need to contact the bank and request money?" No, reimbursing medical expenses does not count - you must contact the HSA custodian as noted above and ask for a return of the contributions. Be sure to use the phrase "withdrawal of excess contributions" so that the custodian does not mark this internally as a distribution which would be penalized at 20%.

TurboTax will add the amount of the excess to their Other Income, so they will pay tax on it. But they will receive a check from the HSA custodian for the amount of the excess, so they will be able to cover the additional tax.

[brian-perrigino]

Thank you @BillM223 

A couple follow-ups if I may.... the overfunding was a result of employer reimbursement.  If the excess funds are removed, who gets the money.... the individual who had the overfunding (J in this case), or does it go back to the employer?   Its sounds like J correct?   And would the 1099-Misc be for 2022 taxes or 2023?

Also, if I answer TT and say that the excess will not be removed, TT adds in a 6% penalty.  This seems like it would be significantly less that receiving a 1099-Misc and paying tax on $3550 since they are in a high tax bracket.  Is that legit?

[BillM223]

1. If the excess contributions are due to employer contributions (i.e., W-2 box 12 code W), two things can happen:

...A If the employer realizes that you were not eligible for the contribution, then the employer, under certain circumstances, can take it back from your HSA. Of course, the employer would have to re-issue the W-2 so that it does not show up as income and that the code W entry is not there either.

...B Otherwise (which is the usual case), after the taxpayer requests the "withdrawal of excess contributions", the HSA custodian will send a check for the excess to the taxpayer.

2. 1.b will happen because as soon as the excess is found by TurboTax, it will be added back to Other Income, so it is only fair that the taxpayer get the income.

3. The 1099-SA (not 1099-MISC) reporting the withdrawal of excess contributions will generally be for the following year. NOTE: TurboTax has already added the excess back to income, so you don't need the 1099-SA for the current year to pay the tax on the income.

4. You will be assessed 6% penalty if you carryover the excess to the next year, as you note. However, it is NOT cheaper to do this rather than withdraw the excess in the current year before the due date of the return. This is because you will pay income tax on the excess no matter what, so the 6% is in addition to the income tax (check your 1040 for the excess as Other Income).

If you can, withdraw the excess now, and don't try to discharge it next year.

[Opus 17]

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@brian-perrigino wrote:

Thank you @BillM223 

A couple follow-ups if I may.... the overfunding was a result of employer reimbursement.  If the excess funds are removed, who gets the money.... the individual who had the overfunding (J in this case), or does it go back to the employer?   Its sounds like J correct?   And would the 1099-Misc be for 2022 taxes or 2023?

Also, if I answer TT and say that the excess will not be removed, TT adds in a 6% penalty.  This seems like it would be significantly less that receiving a 1099-Misc and paying tax on $3550 since they are in a high tax bracket.  Is that legit?

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On the tax return, because the taxpayer is withdrawing the money and paying the tax, the money belongs to the taxpayer.  There is no procedure for the money to be returned to the employer, and the employer is not notified by either the HSA bank or the IRS.

Depending on what the employee agreed to, the employer might have the right to demand repayment.  For example, if the employee signed a contract that says "I agree that I will be fully eligible to receive this money as a tax-free contribution and that if my eligibility changes, I will return any excess" then the employer might have a case.

When J changed to a family plan, that was a "life event" that arguably should have been communicated to M's employer, but again, that depends on what conditions, if any, M's employer put on the contribution.

I would say it is unusual, but not impossible, for the employer to require repayment, but it would be something that was agreed to in advance.

The excess will always be subject to regular income tax, whether withdrawn or not.  If it is not withdrawn, it will also be subject to a 6% penalty.  And the 6% penalty will recur every year in the future as long as the excess remains in the HSA.  

[Opus 17]

Do M and J have a plan for 2023 so this doesn't happen again?

[brian-perrigino]

@BillM223 Thank you very much.