TY 2021 HSA Excess Contribution Error

[frank1234]

Hello,

I am having an issue where the tax software is picking up an excess contribution of $944.

I switched employers in 2021 and initially had contributed $1,694.08 through my employer. When I switched to my new employer they would contribute to my HSA on my behalf and it came out to $2,850. I closed my original HSA account from my previous employer (through UMB) and requested a distribution of $1,745.87 (investment had grown a small amount). Do I need my HSA custodian to correct their 1099-SA because with the distribution I should be under the $3,600 IRS limit.

Please let me know if I am missing something here.

Thanks.

[HelenC12]

The $3,600 is the HSA annual contribution limit. You and your employer contributed $4,544.08. Your contribution has nothing to do with your distribution amount of $1,754.87 reported on your 1099-SA. 

Contract your HSA administrator. If the 2021 HSA contribution exceeds the allowable amount, the excess must be withdrawn by April 18, 2022 to avoid a penalty (October 15 if you filed an extension).

Additional information: Why am I showing an excess HSA contribution in 2021?

[frank1234]

That's the thing I contacted my HSA administrator and asked to close the account for the excess amount for TY 2021 which is the $1,754.87 = $1,694.08 (which is what I contributed through my previous employer) + $60.79 (what my contribution earned). They mailed me a check and I have statements / emails showing this to be the case.

They listed the total amount on box 1 but I think it should be broken out between box 1 and 2 but I am not too sure because I never had to use this form before.

All in all my from my understanding my HSA balance should be only showing $2,850 which is from my current employer.

[BillM223]

Unfortunately, your understanding is not how HSAs work.

First, you should not have closed your prior HSA. Instead, you should have asked the old HSA custodian to do a trustee to trustee transfer of the old HSA funds to the new HSA. 

HSAs are not simple savings accounts from and to which you can add or withdraw funds willy-nilly. In your case, when you closed the old HSA and received a distribution of the $1,7XX, this distribution was not for medical expenses; therefore on your tax return, the amount will be added to Other Income and in addition you will be penalized an additional 20%.

In terms of the annual HSA contribution limit which is $3,600 as Helen says, please understand that HSAs are treated in the aggregate. That is, if you have more than one HSA at the same time or even in the same year, all the contributions to any of your HSAs are added together and applied against that $3,600 limit. The limit is NOT applied to each physical HSA; instead, it is applied to the "virtual" HSA that you have.

So, $1,694.08 contributed to the old HSA and $2,850 contributed to the new HSA adds up to $4,544, which is $944 over the $3,600 limit for 2021.

And again, as Helen says, how much you distributed is not factored at all into the excess contribution issue.

[frank1234]

Hey I understand that it is an aggregate amount which is why I withdrew the $1,754.87 to be under the $3,600 total and closed the account. Why would I go through all the trouble of actually withdrawing the excess amount if it didn't resolve anything? I'm reading through the IRS 2022 instructions for 1099-SA / 5498-SA and nothing I did points to me doing anything wrong.

My 1099-SA shows on box 3 the distribution code of 2. Per IRS instructions it lists: Use this code for distributions of excess HSA or Archer MSA contributions to the account holder.

Even on this site it says the following which I did "If the 2021 HSA contribution exceeds the allowable amount, the excess must be withdrawn by April 18, 2022 to avoid a penalty (October 15 if you filed an extension)."

It is unfortunate because it seems there is a lack of understanding because we are typing this out and you can't see my forms...

[BillM223]

As I noted, the HSA is not a regular savings account. When you withdrew the $1,754.87, did you tell the HSA custodian that this was a withdrawal of excess contributions? If not, then they have it on their books as a regular distribution. We need to clean that up if possible.

Yes, I understand that you withdrew it to try to solve a problem, but the problem is that when you entered the $1,7XX from the first HSA and the $2,850 for the second HSA, you exceeded the annual HSA contribution limit. The way TurboTax works is that it expects you not to do any withdrawals until you know the actual amount to withdraw which TurboTax will tell you while doing your tax return. As you can see, while you thought the excess would be $1,694.08, it's actually $944. So you could explain in TurboTax the $944 as the excess, but not the other 1,694.08-944 = $750.08 that you withdrew when it was not actually in excess. This becomes a distribution not for medical expenses so is taxed and penalized.

From page 7 of Pub 969.

"Rollovers

A rollover contribution isn’t included in your income, isn’t deductible, and doesn’t reduce your contribution limit.

Archer MSAs and other HSAs. You can roll over amounts from Archer MSAs and other HSAs into an HSA. You don’t have to be an eligible individual to make a rollover contribution from your existing HSA to a new HSA. Rollover contributions don’t need to be in cash. Rollovers aren’t subject to the annual contribution limits. You must roll over the amount within 60 days after the date of receipt. You can make only one rollover contribution to an HSA during a 1-year period.

Note. If you instruct the trustee of your HSA to transfer funds directly to the trustee of another of your HSAs, the transfer isn’t considered a rollover. There is no limit on the number of these transfers. Don’t include the amount transferred in income, deduct it as a contribution, or include it as a distribution on Form 8889."

So when did you receive this distribution from the old HSA? Was it less than 60 days ago? Then immediately contact your new HSA custodian and tell them that you have a rollover to give them. 

Then, when you enter the 1099-SA from the old HSA, you will enter the amount in box 1 and the distribution code in box 3 (code "1"). On the next screen, you will admit that you did not spend this amount on medical expenses only )(i.e., say NO). Then say that you didn't spend any of it on medical expenses, then you will see a new line that asks you how much you rolled over into another HSA. Enter your $1,694.08 here and it will not be added to Other Income nor penalized.

However, a rollover done like this still counts towards your annual HSA contribution limit, which is why you still have an excess of $944. It seems odd, but it's the way HSAs work. Unfortunately, Pub 969 doesn't do a very good job of explaining the nuances of handling HSA contributions and distributions.

Does this work for you? 

[frank1234]

Yes, I called the rep and specifically asked them to treat it as an excess contribution I filled out their form which listed the below:

I am requesting to withdraw funds due to contributions made to my account that placed me in excess  contribution status. By signing at the bottom of page 2, I understand that UMB will report this distribution to  the IRS as an excess contribution. Funds contributed in excess of your contribution limit are subject to penalty and tax unless the excess and earnings are withdrawn by you prior to your tax filing due date, including any extensions, for filing your Federal Income Tax return. You should consult a qualified tax advisor in connection with your excess contribution removal.

Wouldn't them listing the distribution with code 2 treat it not as a regular distribution? They didn't use code 1 (Use this code for normal distributions to the account holder and any direct payments to a medical service
provider. Use this code if no other code applies. Also, see Distribution after year of death, earlier) which would treat it as such.

[BillM223]

"Yes, I called the rep and specifically asked them to treat it as an excess contribution I filled out their form" - good

"I am requesting to withdraw funds due to contributions made to my account that placed me in excess  contribution status. " - the problem is that the $1,694.08 didn't put you in excess contribution status, only the $944 did. In other words, $750.08 of the $1,694.08 was never an excess contribution, so you should not have withdrawn it.

"Funds contributed in excess of your contribution limit are subject to penalty and tax unless the excess and earnings are withdrawn by you prior to your tax filing due date, including any extensions, for filing your Federal Income Tax return." - the problem is that it should read "ONLY Funds contributed in excess..." The rules don't allow you to just withdraw any amount you want, unless it is for a qualified medical expense.

"You should consult a qualified tax advisor in connection with your excess contribution removal" - this is true, because the rules for contributions and distributions for HSAs are poorly understood by taxpayers, HR personnel, and even the HSA custodians themselves. 

In this case, the HSA custodian took you at your word that the $1,694.08 was an excess contribution, so they issued the 1099-SA with a distribution code of 2 (the right thing to do). However, you can't know the actual excess amount until the end of the year, when a tax advisor who actually understands HSAs or TurboTax tells you what your excess (if any) is.

If you had withdrawn only $944, then you would be fine, but you didn't. The remaining $750.08 is considered a distribution for reasons other than medical expenses, therefore subject to being added to Other Income and a 20% penalty.

What you might try is contacting your old HSA custodian and asking if you can declare the $1,694.08 as a mistaken distribution - it should have been $944. They would want you to fill out a form and have you send them a check for $750.08. This would make all the paperwork right.

The problem is that HSA custodians do not have to accept a request to handle a mistaken distribution. If they do, then they will issue you a new 1099-SA, BUT since you have closed the account, they may pass on doing anything at all. Be nice when you ask, grovel if you have to, because the "otherwise" is that you have tell TurboTax that you will withdraw the $944 excess (true because you have already done it), and when you enter the 1099-SA (the current one), you will have to tell TurboTax that $750.08 was not for medical expenses.

We have one more option (since I doubt the old HSA custodian will accept your mistaken distribution request): do you have $750.08 in unreimbursed (by the HSA or insurance) medical expenses incurred after the date the old HSA was funded? If so, collect all those receipts and write yourself a note that you withdrew the $944 as the excess and the $750.08 to reimburse yourself for unreimbursed medical expenses (which you are allowed to do without regard to the tax year, so long as the medical expense was incurred after the start date of your HSA - in your case because the two HSAs were so close in time, it's the start date of your old HSA (i.e., the date you first funded it).

Look at Pub 969 on page 9 under ""Qualified medical expenses" to note the items that are not considered medical expenses for Schedule A, but which CAN be reimbursed by an HSA, such as over-the-counter and menstrual care products bought since 2019. Also, part of the premium for long-term care insurance.

Keep this documentation in your tax files, so that if you are ever audited, you can justify the $1,694.08 withdrawal.