Tag Archives: Excess Contributions

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.

How to Handle Excess Contributions on HSA Tax Form 8889

Overview

Excess Contributions occur when you contribute more to your HSA than you were allowed. This compares your contribution limit for the year (which can vary on many factors) and the actual amount of money that came into your HSA, including such things as Employer Contributions, Qualified Funding Distributions, and Prior Year Contributions. That being said, if you find yourself in a situation facing Excess Contributions, you may find it a challenge come tax time when you are faced with Form 8889. Fear not, as this article will guide you through how to avoid taxes and penalties and get this IRS required tax form filed.

Include the Excess Amount in Contributions

Part I of Form 8889 is appropriately called “Contributions”. It details amounts contributed to your HSA, your contribution limit, and calculates the deductible amount that flows over to Form 1040. It will feel strange, but you want to include all amounts contributed to your HSA, even if they are in excess. Doing so accurately reflects the account activity, so that when your HSA custodian provides Form 5498-SA to the IRS, the amount contributed will match your Form 8889. Remember, there is no taxes and penalty for having excess contributions in your HSA, if you remove them (and any earnings) before your tax filing deadline. The point is it is OK to show excess contributions in the contribution section of Form 8889, the key is that you have to proactively take care of them.

Example: Excess Contributions on Form 8889 Part I – Contributions

In this example we contributed $4,850 (contribution, employer contribution, and funding distribution) to our HSA. However, our contribution limit was only $3350, leading to an excess contribution of $1,500. The key is that we have included all contributions that caused the excess contributions and lived to tell the tale.

An example of 2016 Form 8889 prepared by EasyForm8889.com

HSA_excess_contribution_form_8889_1

Notice the warning at the bottom that states:

“Caution: If line 2 is more than line 13, you may have to pay an additional tax (see instructions).

Our Line 2 ($4,350) is indeed greater than Line 13 ($2,850), so we are at risk of paying excess tax. However, per the instructions, if we remove the excess contribution and any earnings on it before the tax deadline, we owe no taxes or penalty:

HSA_Excess_Contribution_instructions

To rectify this scenario, we would need to log into our Health Savings Account and request a distribution that specifically states it is a removal of an excess contribution for 2016 (see next section). You must specify this so that they don’t code it as a regular distribution for qualified medical expenses. In the above example this would be for $1,500 coming back out of the HSA. We will account for that removal in the next section.

Include the Excess Amount in Distributions

Part II of Form 8889 is called “Distributions” and details money that came out of your HSA. Similar to the logic stated in Part I, we need to be transparent about the excess contribution to avoid the ire of the IRS (and taxes and penalty). We will do this by 1) counting the removed excess contribution as a distribution and 2) calling it out as a distribution due to excess contribution. Again, you need to remove excess contributions (and any earnings) from your HSA before the tax filing deadline, and doing so creates a distribution from your HSA.

To actually remove the excess contribution, you need to go to the website of your HSA custodian and create a distribution for the excess contribution. When you do this (important), there should be a box stating “I am removing an excess contribution from my HSA”. This differentiates the distribution from one being used for qualified medical expenses, and informs your HSA custodian how to code the distribution on Form 1099-SA. If you correct the excess contribution before tax year end, this distribution will be reported on that year’s Form 1099-SA. If you do this in the following year (say, Jan-April 15th, before tax day), your HSA custodian may or may not send you a 1099-SA for the distribution before tax day. If they don’t, you need to keep that distribution of excess contributions in mind for filing taxes.

Example: Excess Contributions on Form 8889 Part II – Distributions

Reporting this activity on Form 8889 is relatively easy, as there is a mechanism in Line 14 that handles excess contributions for us. Back to our example of a $1,500 excess contribution that was removed, our Form 8889 ends up looking like this:

An example of 2016 Form 8889 prepared by EasyForm8889.com

HSA_excess_contribution_form_8889_2

Line 14 has 3 parts that we use to detail our distributions. We include the excess contributions removed in this total amount, and call out the amounts that were removed due to excess in 14b. The breakdown of line 14 is below:

Line 14a – The total amount of distributions for the year, including those for excess contributions and their earnings
Line 14b – Distributions that were for excess contributions and their earnings
Line 14c – A calculation of distributions that should have been spent on qualified medical expenses

As you can see, excess contributions avoid taxes here because they are excluded from Line 14c. If any amounts in 14c are not spent on qualified medical expenses, they are taxed and penalized. We stated that $300 that we normally distributed was spent on qualified medical expenses, by tracking our receipts in a tool like TrackHSA.com. The takeaway from the above logic is that the IRS does not expect you to spend excess contributions on QME, and does not tax or penalize you on these distributions if they are handled properly.

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Note: if you want step by step instructions for your Excess Contributions on Form 8899, or just want to get it right the first time, please consider using my service EasyForm8889.com to complete Form 8889. It is fast and painless, no matter how complicated your HSA situation may be.

How to Remove Excess Contributions to an HSA

Overview

The IRS defines a maximum amount that you can contribute to your Health Savings Account each year, appropriately called the HSA Contribution Limit. This amount varies each year (adjusted for inflation) and is impacted by your age, type of insurance, and length of coverage during the year (see: 2017 HSA Contribution Limits). You cannot legally contribute more than the HSA Contribution Limit, but what if you accidentally do? These are called Excess Contributions and they can lead to penalties, paperwork, and headache. We will show you how to remove or apply personal and employer excess contributions and avoid penalty.

What are HSA Excess Contributions?

By definition, an excess contribution results when you over contribute to your HSA for the year. But what is over contribute? The first step is defining your contribution limit for the year. The IRS defines HSA contribution limits by type of insurance coverage: Self-only or Family. For 2017, these amounts are $3,400 and $6,750, respectively. You can also contribute $1,000 more if you are over 55 per the Catch-Up Contribution. These totals assume full year coverage, and your contribution limit is reduced proportionately for partial year coverage.

Once you know how much you can legally contribute, the second step is determining the amount you actually contributed to your HSA. While this sounds simple, there are multiple sources to consider here. When calculating excess contributions, the IRS defines your HSA contributions as:

Amounts contributed for the year include contributions by you, your employer, and any other person. They also include any qualified HSA funding distribution made to your HSA. Any excess contribution remaining at the end of a tax year is subject to the excise tax.

If your HSA contributions exceed your contribution limit, you have an excess contribution. Knowing this value will be key for rectifying the discrepancy.

Why This Happens

There are a few common scenarios that result in Excess Contributions, given the various factors that determine your contribution limit on Form 8889. Here are the most common situations that can lead you to over contributing:

Too many contributions – This is just a simple technical issue of too much money going into your account, likely due to a math error or unexpected contribution. For example, if your contribution limit was $3,400, and each month you contributed $300 to your HSA, you would contribute $3,600 for the year. This leaves $200 in excess that needs to be removed.
Employer contributions – A similar scenario occurs with employer contributions to an HSA. Granted you are quite lucky but perhaps it is unclear how much they will contribute. Or your employer contributes a variable amount based on some factor. Either way, employer contributions count toward your maximum HSA contribution so these must be included in a calculation of Excess Contributions.
Miscalculated your contribution limit – This is the most subtle (and painful) way to over contribute. In this example, you assumed you were allowed to contribute $3,400 to your HSA this year, which you did. You find out that you were only an eligible individual for 10 months, so your contribution limit is really 10/12ths of your max contribution limit. Or, you front loaded your HSA contributions early in the year and then lost HSA eligible insurance. In either case, there is too much in your HSA for the year and you need to remove it.

Excise Tax

The government imposes penalties if you over contribute to your HSA. Per the IRS guidelines:

Generally, you must pay a 6% excise tax on excess contributions. See Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, to figure the excise tax. The excise tax applies to each tax year the excess contribution remains in the account.

So a few important points here. The penalty rate is 6% on the amount of calculated excess contributions. Not sure how 6% was determined but it is very close to an expected rate of return in the market. Either way, the kicker is you must pay this penalty each year the excess contributions remain in your account. So this is the gift that keeps on giving and you must rectify anything over contributed to avoid tax and penalty.

How to Correct Excess Contributions

Luckily, the IRS is lenient on fixing excess HSA contributions. They provide two options of correction: removal or future application. The first removes the HSA contributions in the tax year and avoids a penalty – no harm, no foul. The second “let’s them ride” in the account where they can be applied to a future year’s contribution, but incurs a penalty each year. We will walk through both scenarios below.

Option 1: Remove in the Current Year

This is probably the preferred option. If you catch your mistake before you file your taxes, you can avoid all penalties by removing the excess contributions (and any of their earnings) from your HSA and treating them as normal taxable income. Per the IRS:

You may withdraw some or all of the excess contributions and not pay the excise tax on the amount withdrawn if you meet the following conditions.
1) You withdraw the excess contributions by the due date, including extensions, of your tax return for the year the contributions were made.
2) You withdraw any income earned on the withdrawn contributions and include the earnings in “Other income” on your tax return for the year you withdraw the contributions and earnings.

The IRS spells it out pretty clearly there, but the removal of the excess contributions and the earnings on those excess contributions must occur before your tax due date. The removed is taxable since HSA tax benefits do not apply. Earnings on excess contributions occur if your HSA is invested or earning interest. Removing those seems fair, since those investments shouldn’t have been made in the first place. The IRS solves all of this by saying just remove them, don’t deduct (i.e. pay tax on ) the excess amounts, and declare any earnings as other income. Could be worse.

Since dollars in your HSA are fungible, it is very difficult to determine exactly which investment they were put into and from where they should be removed. This makes it difficult to determine the exact earnings for the dollars specifically declared excess contributions. Thus, the IRS permits an “average” determination of the gains of the HSA during that time, and the pro rata share of those average gains that can be attributed to excess contributions.

Forms for Removing Excess Contributions

You will need to specifically inform your HSA trustee of a correction and that you wish to remove an excess contribution to your HSA. This triggers them to classify the transaction separately, as opposed to a normal withdrawal for qualified medical expenses. They will proceed to file an additional Form 1099-SA showing the excess contribution being distributed from the HSA with a distribution code of “2”. Be sure to remove and identify any earnings on the excess contribution as well. This form will be provided to you to indicate 1) a distribution from the account that 2) was for excess contributions. The form will look something like this:

hsa-form-1099-sa-completed-excess-contribution-for-2016

The other thing that should occur is your HSA trustee will correct your Form 5498-SA which shows HSA contributions for the year. While they initially would have included your excess contribution (they didn’t know it was excess), once you alert them and withdraw it, they will remove it from Form 5498-SA. That means that your Form 5498-SA will be accurate for the year and should not include any excess contributions.

Option 2: Apply to a Future Year

Alternatively, you can use an excess contribution as your HSA contribution in a future year. You just let your excess contribution sit and then apply it later; the downside is there is a 6% per year penalty. The mechanism that allows this is the deduction, since next year you won’t actually deposit the contribution (it is already there), you will just deduct it on Form 8889. As an example, if you have excess contributions in 2016, you can let them sit there until 2017 and then use them as your contribution for 2017. Rolling an excess contribution to a future year is allowed per the IRS Form 969:

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

So the IRS allows you to roll forward excess contributions and not remove them, but apply them to future periods. You can’t apply more than you have in excess and you can’t apply more than that year’s HSA contribution limit. The downside to this plan is that you must pay the 6% excise tax on the excess contribution for each year it remains in your account as excess (i.e. not applied).

Removal Deadline

To avoid penalty, you must remove excess HSA contributions in the year that they occur. This must be done before your tax filing deadline. Note that this includes extensions, so filing an extension on your taxes increases the amount of time you have to remove the excess. If you elect to apply the over contribution to a subsequent tax year’s HSA, the deadline is the same. While you will eat the 6% penalty the first year, you have until you file your taxes to declare the excess a contribution and deduct it from your taxes.

Excess Employer Contributions to an HSA

While employer contributions are normally a great thing, they can cause some pain should they become excessive (hah!). Since employer contributions to your Health Savings Account count toward your yearly contribution limit, you must factor them into your limit. Three situations can arise from employer contributions:

Employer and Employee over contribute – If both you and your employer contribute to your HSA, the onus is on you to not over contribute. Thus any over contribution is from the employee and the employer cannot claw back their contribution (see next section).
Employer alone over contributes – In this case, the employer can file to have the contributions (and earnings) returned by December 31st. If they fail to do this, the excess amounts will be filed as income on the W-2 and the excess will need to be removed by the employee.
Employer contributes to ineligible individual – The unlikely event that an employee is not eligible but receives HSA contributions functions much like the above example. If it is caught by December 31st, it can be recovered, but after that it becomes wages and the monies do not function as an HSA (just a regular account).

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Note: if you have an HSA, please consider using my service EasyForm8889.com to complete Form 8889. It is fast and painless, no matter how complicated your HSA excess contributions may be.