Recently employed dependent child and HSA contributions

[jfm2023]

My 23 year old daughter graduated from college in June of ’24, got a job in August and signed up for a high deductible health plan with her employer. She then elected to participate in an HSA and contributed $1,500 from Aug-Dec of last year.  We’re doing her taxes In TurboTax Deluxe Desktop, and are getting errors about having excessive contributions since I am claiming her as a dependent on my own return.  Is she not eligible to maintain and contribute to an HSA while she’s my dependent?  If she can, does she have to pay taxes on the total amount contributed?  How do I manage this in TT because at one point, the amount of her excess contributions doubled from what showed on her W-2, why was that?  What is the correct way to handle this in the software as we seem to be stuck in an endless loop of checking and unchecking boxes that says she was covered by the plan for part of the year and no plan for the remaining months (she was on my health plan before she started work). Incidentally, she did have a small disbursement from her HSA account to pay for a medical related expense but the bulk of it is still there.

[maglib]

@jfm2023 

The IRS has the following requirements for individuals to qualify for an HSA and sadly if you claim her, she can not have an HSA:

• Enrolled in a high deductible health plan (HDHP) with no other disqualifying health coverage that pays for treatment before a deductible is reached.
• Not enrolled in Medicare
• Not claimed as a dependent on another person's current year tax return

Another note is your daughter should be covered by your healthcare plan till 26.

Your daughter can have the HSA reversed as IRS changed rules:
IRS Notice 2008-59
In Notice 2008-59, the IRS clarified limited circumstances under which an employer may recoup contributions
that it makes to an employee’s HSA. These limited circumstances are:
If an employee was never eligible for HSA contributions (that is, the employee never met the eligibility
criteria for an HSA); or
If an employer contributes amounts to an employee’s HSA that exceed the maximum annual
contribution amount due to an error.
In these circumstances, Notice 2008-59 says, the employer may request that the financial institution return to
the employer the mistaken or excess amounts contributed to the employee’s HSA.
However, Notice 2008-59 also states that the employer may not recover amounts contributed that are less
than or equal to the maximum annual contribution limit, even if made in error. Also, Notice 2008-59 says that
if an employer contributes to the HSA of an employee who ceases to be an eligible individual during a year,
the employer may not recover contributions made after the employee stopped being eligible.
New IRS Information Letter
The IRS’ Office of Chief Counsel recently released an information letter (Letter 2018-0033) that clarifies the
ability of employers to recover contributions to employees’ HSAs that were made by mistake. This
information letter expands on the guidance in IRS Notice 2008-59 by allowing employers to recover HSA
contributions in more situations.

HSA information is entered in 2 sections of TurboTax. First in Wages & Income as a W-2, 12 code W. But then you have to also enter it in the Deduction & Credits section under HSA, MSA Contributions too. So long as you meet all the requirements such as only using the HSA distributions for medical purposes and having a high-deductible health plan (HDHP) then your contributions on the W-2, box 12, Code W will not be taxed. 

Tax Tip:  If you took any distributions from your HSA then you will receive a 1099-SA.

Have you done an analysis to see if it is better for your daughter to claim herself?  Is she eligible still to be your dependent?  https://www.irs.gov/pub/irs-pdf/p501.pdf

Tests To Be a Qualifying Child Tests To Be a Qualifying Relative
1. The child must be your son, daughter, stepchild, foster child, brother,
sister, half brother, half sister, stepbrother, or stepsister, or a descendant
of any of them.
2. The child must be (a) under age 19 at the end of the year and younger
than you (or your spouse if filing jointly); (b) under age 24 at the end of the
year, a student, and younger than you (or your spouse if filing jointly); or
(c) any age if permanently and totally disabled.
3. The child must have lived with you for more than half of the year.2
4. The child must not have provided more than half of the child’s own support
for the year.
5. The child must not be filing a joint return for the year (unless that joint
return is filed only to claim a refund of withheld income tax or estimated
tax paid).
If the child meets the rules to be a qualifying child of more than one
person, generally only one person can actually treat the child as a
qualifying child. See Qualifying Child of More Than One Person, later,
to find out which person is the person entitled to claim the child as a
qualifying child.
1. The person can't be your qualifying child or the qualifying
child of any other taxpayer.
2. The person either (a) must be related to you in one of the
ways listed under Relatives who don't have to live with you, or
(b) must live with you all year as a member of your
household2
(and your relationship must not violate local law).
3. The person's gross income for the year must be less than
$5,050.3
4. You must provide more than half of the person's total support
for the year.

[DavidD66]

The problem is that your daughter is being claimed as a dependent on your tax return.  According to the IRS:

To be an eligible individual and qualify for an HSA contribution, you must meet the following requirements.

• You are covered under a high deductible health plan (HDHP), described later, on the first day of the month.
• You have no other health coverage except what is permitted under Other health coverage, later.
• You aren’t enrolled in Medicare.
• You can’t be claimed as a dependent on someone else’s 2024 tax return.

You have two options.  The first is do not claim your daughter as a dependent on your tax return.  If you have already filed, you could file an amended return.  The second is for your daughter to "undo" her HSA.  To do that, she will need to remove the money from the HSA.  I recommend she contact her HSA administrator on how to remove the funds and report it.  It is not treated as a removal of excess contributions.  She should not file her return until she has resolve the issue, unless you decide not to claim her.  

[jfm2023]

Is there a third option whereby she can just pay a tax on the HSA contributions that her employer made?   Next year she will want her HSA and I will not be able to claim her as my dependent since she will be 24 before the end of the year.

[BillM223]

OK, you now see that a dependent cannot make contributions to an HSA.

The easiest way to deal with this is for your daughter to withdraw the excess before April 15th. She would pay income tax on the amount of the excess, but no penalty.

Plan B would be to carry over the excess (in part or all) to 2025, when it sounds like she would be eligible because she would no longer be your dependent. The good news is that so long as she treats the carryover as a personal contribution, and does not contribute more than the limit in 2025 (including the carryover), then the carryover will be "used up" and no longer be a carryover or penalized. The bad news is that this will cost her a 6% penalty on her 2024 return. NOTE: the 6% penalty is 6% of the lower of her carryover or the amount in her HSA at the end of the year. 

So you get to decide how much you want to withdraw. The cheapest thing would be to withdraw as much as you can, letting a "little bit" be the carryover, to used used up in 2025. Or you can let the entire excess ride to 2025, so that it is all available for medical payments now, but with a larger 6% penalty.

[jfm2023]

Just to clarify, the contributions made to her HSA were by her employer only. So, if she contacts the plan administrator and asks that the monies be withdrawn, she would not have to pay any income tax on those monies because they weren't hers, correct?  In reference to the carry over option you mentioned, knowing that the contributions weren't hers but her employer's, is carrying over still an option?

[BillM223]

1. IF the employer will withdraw the money, that's fine. Not all employers will do this, because they might claim that they had no way of knowing that she was not eligible. NOTE, this means that her employer has to withdraw the money, not your daughter. If her employer does this, then they would have to issue a corrected W-2 (one with no code W in box 12).

2. It makes no difference if the contributions were from her employer or from her by payroll deduction, in terms of making a carryover. 

NOTE: if you decide that your daughter will withdraw part or all of the excess. then your daughter must call her HSA custodian and ask for "a withdrawal of excess contributions" (use these words), so that the HSA custodian can keep their paperwork straight. There is often an online form for doing this on the custodian's website.

The difference on whether your daughter pays income tax on the excess is subtle.

IF THE EMPLOYER withdraws the money, then your daughter should get a corrected W-2. In this case, she pays no income tax because it is never listed as income on her W-2.

BUT AS IS MORE LIKELY, your daughter ends up withdrawing the amount of the excess and has to pay income tax on it...but think about it - your daughter has more income in this case, so she is actually better off. Her income will be her Box 1 amount plus the excess. Yes, she if paying tax on it, but so what, she has more money in the end.

[Opus 17]

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@jfm2023 wrote:

Is there a third option whereby she can just pay a tax on the HSA contributions that her employer made?   Next year she will want her HSA and I will not be able to claim her as my dependent since she will be 24 before the end of the year.

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There are two issues affecting her eligibility.

1. She can't make contributions if she is a dependent.

2. She can't make contributions if she is covered by non-HDHP insurance, even if she is also covered by HDHP insurance.

So she is not eligible for 2024.  Will she be eligible for 2025?  It depends on her insurance.  If she is only covered by her own HDHP, then she is eligible, and she can use the last month rule to contribute up to the full year limit.  But, if she will be covered by your insurance as well (that is allowed up to age 26), then she can't contribute for 2025 unless your insurance that covers her is also an HDHP.

The consequences for leaving the money in the HSA are that it is added to her taxable income AND she pays a 6% penalty.  The consequences for removing the money as an excess contribution is that it is added to her taxable income but she does not pay the penalty.  (So it is added to her taxable income either way.). She does not have to return it to the employer, she can keep it.  

And, if she did leave the money in the account and pay the 6% penalty, then next year she can apply it toward the 2025 limit and "use it up".  In other words, since the 2025 limit for a single HDHP is $4300 and she has a $1500 excess, that excess will be used up in 2025 as long as she contributes $2800 or less of new funds.

So if you do nothing, she pays income tax plus a $90 penalty and can contribute $2800 next year.  If she withdraws the excess she pays income tax, no penalty, and her 2025 limit is the full $4300.

To withdraw the excess, you have to ask for a special procedure at the HSA bank, it is not a regular withdrawal.  They must also return any interest that was earned, and that is taxable "other income" on her 2024 return even though the interest is not actually paid to her until 2025. 

[Opus 17]

@jfm2023 

I made a typo in my answer above.

So if she does nothing, she pays income tax on the excess plus a $90 penalty and can contribute $2800 next year.  If she withdraws the excess she pays income tax, no penalty, and her 2025 limit is the full $4300.

[ShawnDL]

What does it mean to “let it ride”? How do I/where do I make the selection? We’ve already filed our taxes claiming our 22 yo as a dependent. She’s still in school but got a full time job mid October 2024 and now has a HDHP with an HSA. We did not know that she could not have both and kept her on our insurance which is not an HDHP until the end of the year. Her employer apparently made a contribution to her HSA at the end if 2024 and that “excess” is now a problem on TT. She will be filing independently for tax year 2025, so rolling it over is fine. She won’t exceed the maximum contribution for 2025. But I don’t understand how to roll that excess over to 2025 on the forms. . 

[BillM223]

To carry over that excess to 2025, you/she needs to not withdraw all the excess on the screen when TurboTax tells you that she has excess contributions. TurboTax asks if you want to withdraw none, some, or all of the excess contributions. 

She took a distribution, as I understand, so she cannot withdraw the entire excess because the cash is not in the HSA.

That's OK, withdraw what you can, and TurboTax will carry the remainder over automatically to 2025. You do not need to contact the HSA custodian for the carry over; you only need to contact the HSA custodian for the withdrawal of excess contributions (that are to be withdrawn). Other than telling TurboTax how much you will withdraw, you don't have to do anything else in TurboTax.

The carryover will be applied to line 2 on form 8889 as a "personal" contribution. I think I saw that you understood that she need to reduce he other contributions in 2025 so that her total does not exceed $4,300 (assuming that she has a Self-only policy). Then, at the end of 2025, the carryover will be "used up" and done with.

Oh, while I am thinking about it, make the withdrawal request for this year's excess before April 15th, i.e., Monday  or Tuesday. When you/she asks for the withdrawal, print the request to document it because I doubt the HSA custodian will deliver the money before April 15th. Just keep the documentation that you started the withdrawal process before April15th.

[Opus 17]

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@ShawnDL wrote:

What does it mean to “let it ride”? How do I/where do I make the selection? We’ve already filed our taxes claiming our 22 yo as a dependent. She’s still in school but got a full time job mid October 2024 and now has a HDHP with an HSA. We did not know that she could not have both and kept her on our insurance which is not an HDHP until the end of the year. Her employer apparently made a contribution to her HSA at the end if 2024 and that “excess” is now a problem on TT. She will be filing independently for tax year 2025, so rolling it over is fine. She won’t exceed the maximum contribution for 2025. But I don’t understand how to roll that excess over to 2025 on the forms. . 

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For 2024, the excess must be added back to her taxable income, and is subject to an additional 6% penalty.

For 2025, she just has to contribute less than the maximum allowed.  For example, suppose her 2024 employer contribution was $500.  The 2025 limit for single HDHP coverage is $4300.  All she has to do is contribute equal or less than $3800.  Your tax software will automatically apply the $500 excess from 2024 to the new limit for 2025, and it won't be considered excess any more.  This is worked out on form 5329.