Removal of HSA Excess Contributions

[BillM223]

"all of the distribution was for qualified medical expenses" - this question is asked in the 1099-SA subinterview in the HSA interview. That is, when you call the HSA custodian and ask for a distribution, the custodian will issue a 1099-SA which will include all distributions for the year.

Normally, the 1099-SA is received early in the subsequent year for the previous year's tax year.

An alternative is to claim that some of the expenses for 2019 that were for medical expenses were not.

Note that at this point, you should have already received a 1099-SA for tax year 2019. Go back through the HSA interview and Edit the 1099-SA that you have already entered.

Then, when you see this question, enter that not all of the expenses were for qualified medical expenses (even if they were), and enter an amount equal to this long-running carryover. This will trigger the process in your 2019 return to eliminate the long-running carryover.

TurboTax never gets to step 4 because you haven't yet revisited the 1099-SA interview to see that not all expenses were qualified dialogue.

Note that this alternative works for 2019 (the first thing I mentioned works for tax year 2020), but it assumes that you have 1099-SA for tax year 2019 that is at least as large as the long-running excess. If you don't have such a 1099-SA for 2019, then you will have to do the 4 steps I outlined above for tax year 2020, that is, ask for the distribution now and report it on your 2020 return.

[Robert87]

Thanks for all of the suggestions.  I think that I understand what you are suggesting as the alternative which implies that we had medical expense distributions in 2019.  This really does not make sense to me as the IRS Form 1099-SA has a box number 3 called "Distribution code"  which is defines codes to identify the distribution that was received from the HSA custodian where a value of "1" means that it was a Normal Distribution and a value of "2" means an Excess Distribution.  In 2018 we received multiple 1099-SA forms, with different values in Box 3.  The 1099-SA that had value of "2" in Box 3 was equal to the amount that we withdrew as excess contributions.  Isn't the purpose of the 1099-SA to provide the amount the HSA Custodian reported to the IRS as distributions to include the excess contributions that we withdrew?

So what I don't understand is that we completed our tax return for 2018 using these 1099-SA forms and were never asked by Turbo Tax any of the questions that you state we should have been asked.  Why?

Why would we need to claim that legal medical expenses were not medical expenses to remove the excess contributions?

Lastly, still want to know how we can remove the excess contributions in our 2019 tax return?

[BillM223]

Actually, when the distribution code is '2', the amount in box 1 for the distribution is ignored by TurboTax. Why? Because the excess contribution was already automatically added to Other Income in the year that the excess was made (i.e., the first year, not in subsequent years). We don't need the box 1 amount.

When the distribution code is '2', we will look only in box 2 for earnings, which we will add to Other Income for the year it is reported.

I assumed that you had received a 1099-SA for 2019, because I had assumed that you made payments out of your HSA every year for qualified medical expenses. When you enter the 1099-SA, that is when you see these questions about qualified medical expenses.

If you did not receive a 1099-SA early this year for 1099-SA, either you made no such distributions in 2019, or the custodian failed to get it to you (you can always go to their website and get it yourself).

In any case, if you should not have received the 1099-SA this year, you can force it next year by calling the custodian right now and asking for a distribution equal to the amount of the long-running carryover. Yes, it will come with distribution code of '1' because it is a normal distribution from their point of view. But you will be able to tell TurboTax that this amount was not for medical expenses during the 1099-SA interview, and this will cut off the long-running carryover.

[Robert87]

We did have some normal distributions in our 2019 1099-SA but much less than the excess contribtions.  We went back on answered that the amount was not for medical expenses and the amount was removed and taxed the 20%.

We have already made the withdraw for the excess contributions, why would this not remove the excess contributions from prior years in Turbo Tax?  Is there something else we need to do to manually update forms since Turbo Tax does not handle the removal of excess contributions?

Are you suggesting that we again withdraw the excess contribution a second time as a distribution?  Why would we need to withdraw a second time to remove the excess contribution?

[BillM223]

OK, let's see if I got this straight.

You say that you withdrew the excess from 2016 in 2018. However, the carryover persisted and you were still paying 6% penalty on the carryover even up to 2019.

The problem is that in 2018 that you could not withdraw the 2016 excess in the manner prescribed by the IRS.

That is, you may withdraw the excess for a tax year up until the due date of the return. Therefore, when you did the withdrawal of excess contributions in 2018, you were able to properly withdraw the excess created in 2017, but not the excess created in 2016, because the due date of the 2016 return was April 2017.

No doubt part of the confusion is that you did contact the HSA custodian and withdraw the money; however, for the 2016 return, that was not permitted under the rules as it was past the due date of the 2016 return.

When you withdrew the 2016 excess in 2018, what you could have done is this: declare that the amount corresponding to the 2016 excess was not a distribution for qualifying medical expenses. That would have generated the excess as Other Income and the 20%, but that would have been the end of it.

Let me repeat, you "withdrew" the 2016 in 2018 but since it was not according to the rules set up by the IRS governing HSAs, it didn't count. It would have been cut off if you would have declared that withdrawal (the 2016 "withdrawal", not the 2017 withdrawal which was OK) to be not for qualifying medical expenses, because the 2016 excess would have been added to Other Income and the 20% penalty added.

Yes, this means that you could amend your 2018 return, take the hit in 2018, then the issue would be moot for 2019.

If you do this, then you do not have to withdraw the excess again. If you took the money in 2018, then the fix involves paying income tax and a 20% penalty in 2018.

[Robert87]

You stated that "you could amend your 2018 return, take the hit in 2018, then the issue would be moot for 2019" and "the fix involves paying income tax and a 20% penalty in 2018".  Great how can we do this?  I have tried to amend the 2018 tax return but not able to fix it to pay the 20% penalty.  What needs to be done with the amended 2018 return in the Turbo Tax 2018 Deluxe version to accomplish it?

[BillM223]

If you received a 1099-SA in 2018, then when you enter it (well, you already entered it), when TurboTax asks if it was all for qualified medical expenses, answer "No" (even if it was).

Then when it asks how much was nonqualified, enter the amount of the 2016 excess.

You see, you withdrew the 2016 excess in error (according to the IRS) in 2018, so since this withdrawal is not considered a withdrawal for qualified medical expenses, you can tell TurboTax this.

This should add the 2016 excess to Other Income on whatever schedule that was on in 2018 (1?) and modify the 5329 to cut off the 6% penalty for that excess as well as add the 20% penalty in line 17b on the 8889.

[Robert87]

As we discussed earlier the 2018 Turbo Tax Deluxe version never asks me "if it was all for qualified medical expenses", so I never am able to answer "No".  I believe it is because, as mentioned earlier, the 1099-SA has has a "2" in Box 3 meaning it was for excess contributions not a "1" in Box 3 meaning normal distribution.  If the Box 3 has a "1" for normal distribution then Turbo Tax asks "if it was all for qualified medical expenses".  So given this information how do I amend the 2018 tax return to remove the 2016 excess contributions?

[BillM223]

Did you not have any "normal" HSA distributions in 2018 that would have generated a 1099-SA with a code of '1'? (you would have received this in early 2019 along with the other 1099-SA with the code of '2').

If not, then the amending 2018 won't work.

How about in tax year 2019? Did you make any distributions for medical expenses in 2019 so that you got the 1099-SA with distribution code of '1' this year? You can do the same thing here - say that part of the distribution (if the distribution is large enough) was not for qualified medical expenses.

In essence, the earliest time you get a 1099-SA with code '1', do this process of saying that some of it was not for qualified medical expenses, and you'll cut it off that year.

If you haven't gotten a 1099-SA with a code of '1' since  whenever, then you will have to call the HSA custodian to take a distribution, so that you at last will see that question in the 1099-SA sub-interview (in early next year).

Honestly, I just assumed (yes, that's bad) that you had used your HSA at some point.

[Robert87]

1. Are you stating that even though we withdrew the 2016 excess contributions from our HSA that withdraw was for nothing because it was past the 2017 due date, meaning that we withdrew all that money from our HSA and we can't even declare it?

2. If the withdraw was for nothing is there a way to put that money back in the HSA since it was withdrew for no reason?

3. Should the 1099-SA withdraw been coded differently (meaning as a normal distribution) by the HSA custodian so that we could declare it was removed?

4. Something does not seem right that you have to lie about actual medical expenses to remove the excess contributions with a 20% penalty as the only way to remove the excess contributions from being carried over every year.  Is there another way to remove the excess contributions?

Can you please answer each of these questions?

Thanks

[BillM223]

"1. Are you stating that even though we withdrew the 2016 excess contributions from our HSA that withdraw was for nothing because it was past the 2017 due date, meaning that we withdrew all that money from our HSA and we can't even declare it?"

Yes. The excess must be withdrawn by the due date of the return, or else a different process has to be applied to handle it.

"2. If the withdraw was for nothing is there a way to put that money back in the HSA since it was withdrew for no reason?"

At this point, it is too late. You needed to fix that in 2018.

"3. Should the 1099-SA withdraw been coded differently (meaning as a normal distribution) by the HSA custodian so that we could declare it was removed?"

It sounds to me that the HSA custodian made a mistake, in that they let you try to withdraw the 2016 excess in 2018 and filed the paperwork that way (a 1099-SA with a distribution code of '2'). If so, they fouled up. But, unfortunately, it is long past time to fix this.

"4. Something does not seem right that you have to lie about actual medical expenses to remove the excess contributions with a 20% penalty as the only way to remove the excess contributions from being carried over every year.  Is there another way to remove the excess contributions?"

The "lie" is only a way to get TurboTax to do what you want. Remember that lying to TurboTax is not like lying to the IRS. Besides, your HSA custodian apparently violated the HSA reporting rules, and you can't expect TurboTax to have coded its software to handle that.

I gave you this as option if you had a 1099-SA for 2019 (with a distribution code of '1'). If you don't, then you'll have to request a distribution now for that excess amount, and do it in 2020.

You asked me how to cut off the excess carryover - this is how you do it in TurboTax to conform with the IRS rules. 

[Robert87]

Well that is pretty sad news, thanks for answering the questions.

I found in the IRS Pub 969 about  Deducting an excess contribution in a later year. Which states...

You may be able to deduct excess contributions for previ- ous years that are still in your HSA. The excess contribu- tion you can deduct for the current year is the lesser of the following two amounts.

If, under the last-month rule, you are considered to be an eligible individual for the entire year for determining the contribution amount, only those expenses incurred after you actually establish your HSA are qualified medical ex- penses.

• Your maximum HSA contribution limit for the year mi- nus any amounts contributed to your HSA for the year.

• The total excess contributions in your HSA at the be- ginning of the year.

1. So does that mean that if we contribute less than the max HSA contribution limit that this amount will come out of the carried forward amount of excess contributions?

2. If the answer is "Yes" for the prior questions, then does that max limit include the $1000 additional contributions for age 55 and over for my wife and I?

3. If we are able to go this way and reduce our contributions for this year then yes we would have to pay the 6% penalty for our 2019 return but would we be hit with any additional penalty fees?  This may be a better option then paying a 20% penalty fee?

4. Can we reduce the excess contributions over multiple years by contributing a limit less each year?

5. Does it matter which of the HSA accounts (mine and my wife's) contributes less, or are we considered a family and amounts to each HSA does not matter as long as we are less than the max family contribution plus additional contributions for 55 and over?

Please answer all of the questions, thank you.

[Robert87]

Well that is pretty sad news, thanks for answering the questions.

I found in the IRS Pub 969 about  Deducting an excess contribution in a later year. Which states...

You may be able to deduct excess contributions for previ- ous years that are still in your HSA. The excess contribu- tion you can deduct for the current year is the lesser of the following two amounts.

If, under the last-month rule, you are considered to be an eligible individual for the entire year for determining the contribution amount, only those expenses incurred after you actually establish your HSA are qualified medical ex- penses.

• Your maximum HSA contribution limit for the year mi- nus any amounts contributed to your HSA for the year.

• The total excess contributions in your HSA at the be- ginning of the year.

1. So does that mean that if we contribute less than the max HSA contribution limit that this amount will come out of the carried forward amount of excess contributions?

2. If the answer is "Yes" for the prior questions, then does that max limit include the $1000 additional contributions for age 55 and over for my wife and I?

3. If we are able to go this way and reduce our contributions for this year then yes we would have to pay the 6% penalty for our 2019 return but would we be hit with any additional penalty fees?  This may be a better option then paying a 20% penalty fee?

4. Can we reduce the excess contributions over multiple years by contributing a limit less each year?

5. Does it matter which of the HSA accounts (mine and my wife's) contributes less, or are we considered a family and amounts to each HSA does not matter as long as we are less than the max family contribution plus additional contributions for 55 and over?

Can you please answer all of the questions, thank you.

[AS3]

Chiming in here. I answered NO to the question of not withdrawing as advised above, because I am carrying over my excess contribution to the next year- 2020. However, my concern is that the excess amount i am carrying over is showing as my gross income for 2019 (because TT thinks i actually withdrew the money vs carried it over??) 

How do I prevent this? My total income for the year 2019 should NOT include this amount, correct? It seems like I am being charged Federal taxes on it as if it was my income?!

[BillM223]

No, the amount of the excess is appearing on line 8 on Schedule 1 (1040) as Other Income because it was excess, not because it carried over.

I am presuming that the excess contributions were the result of employer contribution, which appears in box 12 on your W-2 with a code of W. Note that this number include both your employer's contributions and any contributions you made by payroll deduction.

Since the code W amount is removed from Wages in boxes 1, 3, and 5 before your W-2 is printed, you aren't being taxed on it. But if some of the code W amount was in excess, it has to be added back to income so that you can be taxed on it.

The system is working correctly.