Category Archives: How To

How to Handle HSA Excess Employer Contributions

I was covered under a high deductible plan but also by my parents’ plan. I didn’t realize my employer would be putting money in an HSA for me. I tried to request a distribution for ineligible contribution from my HSA but the HSA custodian wouldn’t release the money to me since my employer put it in. What are my options?

Add Excess Contributions to Income

It sounds like you had excess employer contributions in 2018. Often this occurs when an employer contributes more than your contribution limit for the year. It also occurs when you receive contributions but are HSA ineligible, like in your case due to multiple insurance coverage. This isn’t the worst thing in the world as it is free money, and all you need to do is add it to income to pay taxes on it. Per Form 969:

HSA-excess-employer-contributions

As you can see, you just add the excess contributions to income and leave the employer contributions in the HSA.

Excess Contributions made by your employer are included in your gross income.

By paying tax on them and keeping them in your HSA, this fulfills their original intent of the contribution being used for qualified medical expenses. The downside here is you have less flexibility on your post tax dollars (compared to if they were in your pocket), but it was free money to begin with.

Note: If you need help preparing your HSA tax form 8889, please consider my service EasyForm8889.com. It asks you simple questions and fills out Form 8889 correctly for you in about 10 minutes.

HSA Non Qualified Withdrawal Tax and Penalty

This question was submitted by HSA Edge reader Adam. Feel free to send in your question today to evan@hsaedge.com.

I have had an HSA for 7 years and have a balance of $7k in the account. If I need to access this money for non medical expenses, what are the penalties I will pay? What are the income taxes, do I pay a taxes on the penalty, and how do I pay this?

Withdrawing Funds from an HSA

Contributions to Health Savings Accounts are intended to be used for qualified medical expenses. If used in this manner, they offer a triple tax advantage that saves you money by decreasing your taxes. However, life presents a lot of challenges, and sometimes you need to access and use your HSA money for other things. In IRS speak, this is called a non-qualified withdrawal, and basically means taking out HSA money for non medical use. This could be anything from a bike, to a vacation, to home appliances. The point is that you need to declare this usage of money since it isn’t abiding by the HSA rules. While the IRS let’s you get your money out, the drawback is you will owe taxes and penalties on this withdrawal.

Before taking a penalty hit, be sure to review all the ways to cash out your HSA. Perhaps you can get creative and avoid taxes and penalty.

Non Qualified Withdrawal – Tax Calculation

First up, you are going to need to pay taxes on your withdrawal. This is reasonable since the funds you contributed were tax free – you got a tax deduction when you contributed them. That tax deduction was predicated on the funds being used for medical purposes, and since that is not the case, it seems fair to pay that tax benefit back. This calculation first occurs on Line 16 of Form 8889. Here, you take you total HSA distributions (Line 14, net) and subtract qualified HSA distributions (Line 15). The result is non qualified distributions, Line 16, also called “Taxable HSA Distributions”. This amount will make its way Form 1040 and be added to income, thus increasing your taxable income for the year. This will either increase your taxes owed or reduce any tax refund.

2017 Form 8889 created using EasyForm8889.com
HSA-Form-8889-Taxable-Distribution-penalty

The actual amount of income taxes you will pay is determined by your marginal tax bracket. The US income tax system is progressive meaning it consists of increasing tax rates in brackets, which are ranges of income amounts. The result is each additional dollar you earn is taxed at your highest rate. For example, if you make a non qualified distribution of $1,000 and are in the 25% tax bracket, you show that extra $1,000 as income and will owe taxes of $250. Note that this marginal tax rate differs from your average tax rate for the year, which is a weighted average of your income in various tax brackets.

Non Qualified Withdrawal – Penalty Calculation

After the taxes, the bad stuff starts happening. Most unfortunately, the IRS penalizes non-qualified withdrawals a whopping 20%. This means that besides taxes, for every $1,000 you take out of your HSA for non medical expenses, you will owe a fee of $200. That is an expensive price to pay to get your money, but sometimes it is worth it.

Back on Form 8889, Line 17b multiplies that “Taxable HSA Distribution” amount by 0.2, i.e. 20%. The result is the amount of penalty you will have to pay to the IRS. This amount makes its way to Form 1040 Line 62 where it is added as a penalty in the form of an additional amount due for the year.

The good news is you do not pay taxes on the penalty amount. As you can see above, the tax amount was calculated and then the penalty amount was determined. Said another way, the penalty calculation is a function of the taxes due, not the other way around. In terms of when this payment must occur, note that all HSA penalties and taxes are payable when you file taxes in the year the non-qualified distribution occurs. This is almost always in the future, so you have until April of the following year to find that tax and penalty amount and pay it to the tax man.

Note: if you have non qualified withdrawals this year, please consider using my service EasyForm8889.com to help complete Form 8889. It is fast and painless, no matter how complicated your HSA situation.

Correct HSA Excess Contribution from Prior Year

This question was submitted by HSA Edge reader Sue. Feel free to send in your question today to evan@hsaedge.com.

I made a contribution on 12/29/16 of $3,000, however, I was not HSA eligible in 2016. How can that be corrected to reflect the correct tax year of 2017? The trustee could not correct it. Should my CPA refile 2016 taxes to report the correction?

Excess Contributions

HSA excess contributions occur when an amount greater than the account owner’s contribution limit is contributed to the HSA. It sounds like you made an excess contribution in 2016 as you were not HSA eligible. While you would like to move that contribution for 2017, it is currently September of 2018, so that tax year is likely closed.

Generally, the remedy for excess contributions is for the account owner to remove the excess contribution from the account before taxes are filed taxes for that year. This can be done on Form 8889, see “Correcting HSA Excess Contribution on Form 8889“. I don’t believe the custodian can fix it for you. That would involve them saying, “This contribution wasn’t for 2016 it was for 2017”. I don’t believe they can roll a contribution forward like that. The only time they can do that is to reclassify a contribution as a prior year contribution, as in, “This 2018 contribution was made before my tax deadline (contribution cut off) and I want it to reclassify it as a 2017 prior year contribution”.

To avoid headaches, remove Excess Contributions in the year they occur.

In your case, since that excess contribution removal did not happen, you may have misstated your 2016 tax returns if you did not pay taxes on that HSA contribution. Said another way, you likely took the HSA deduction on $3,000 when your contribution limit was $0 as you were not HSA eligible. This means you underpaid taxes on that $3,000 of income in 2016.

Leaving Excess Contributions in your HSA

The IRS imposes a penalty for leaving excess contributions in your HSA. This is called the excise penalty and amounts to 6% of the excess contribution per year it remains in the account. Per Form 969:

Generally, you must pay a 6% excise tax on excess contributions (see Form 5329). The excise tax applies to each tax year the excess contribution remains in the account.

So besides having tax deduction headaches, the IRS throws in a yearly penalty on the amount of the excess contribution.

Correcting Prior Year Excess Contributions

Correcting prior year HSA excess contributions involves moving the contribution from when it was excessive to when it was allowed. However, this tricky because it affects tax forms and involves both 1) correcting tax deduction (i.e. paying taxes) and 2) paying the 6% excise penalty in prior years. The procedure is to go back to the source, pay any taxes on the excess contribution, pay any penalties up until contribution is allowed, and then take the contribution in the allowable year. You will receive the HSA deduction when you remake the contribution, so that at least offsets paying the taxes in the prior year.

Correcting prior year HSA excess contributions involves moving the contribution from when it was excessive to when it was allowed.

In summary, I believe the way to correct your situation is to:

Restate 2016 income tax form to remove HSA deduction
Pay 6% excise tax on excess amount in HSA in 2016
Pay 6% excise tax on excess amount in HSA in 2017
Take deduction for contribution in 2018 for amount already in HSA, assuming you still have HSA coverage.

[Note that if you filed an extension for 2017 you may still be able to make the HSA contribution for that year and avoid #3 above.]

Deduct Excess Contribution in a later year

Form 969 also allows you to deduct the excess contribution in a later year. This means that you made an excess contribution in a prior year, did not take the tax deduction then, left it in your account, and later use that amount as a valid contribution in a later year. You thus receive the tax deduction for that year. This option is utilized in step #4 of the solution above. Form 969 states:

You may be able to deduct excess contribution for previous years that are still in your HSA. The excess contribution amount you can deduct for the current year is the lessor of 1) Your maximum HSA contribution limit for the year minus any amounts contributed to your HSA for the year and 2) the total excess contributions in your HSA at the beginning of the year.

Note: if you need help excess contributions this year, please consider using my service EasyForm8889.com to help complete Form 8889. It is fast and painless, no matter how complicated your HSA situation.