Tag Archives: Taxes

Remove Amount Greater than Excess Contribution from HSA

This question was sent in by HSA Edge reader Dale. Feel free to send in your own question.

I was only eligible for an HSA in 2018 for July and switched health plans immediately after my contribution. I contributed $685 which is more than 1/12 of my allowable amount ($371). If I request an Excess Contribution Reversal for the entire $685 + interest, am I allowed to consider my entire $685 as Other Income and just pay income tax on it?

Making and Removing Excess Contributions

Each year, the IRS determines the contribution limit, or maximum amount, one is allowed to contribute to the HSA. However, note that your contribution limit may differ from the IRS limit. Reasons that this may differ are:

Partial year HDHP coverage
Medicare coverage (including retroactive coverage)
Flexible Spending Account (FSA) or other health coverage
Employer Contributions counting towards your limit

Anything above your personally calculated contribution limit is considered an excess contribution. Excess contributions are not good – in effect, you have exceeded the tax deduction afforded you by the IRS. The IRS likes to collect what is due to them, so, understandably, frowns on this.

You can remove excess contributions from your account in the tax year they occur without penalty.

Luckily, there are options to correct Excess Contributions after they occur. This involves removing your excess contribution from your HSA before the tax date of a given year. For most people, this is mid April, though extensions do apply. If excess contributions are not removed, a 6% penalty is due each year for as long as the excess contributions remain in the account. This can add up over time.

You are correct that you can remove the excess contribution for 2018 up until your tax filing deadline (with extension). Per Form 969:

HSA-excess-contribution-removal-IRS-rules

Removing non-Excess Contributions

However, one very important point is that you cannot just remove funds willy nilly from you HSA. In your above example, you contributed $685 compared to your contribution limit of $371. This means you have a $314 excess contribution that can be removed. The whole $685 cannot be removed without penalty.

Any funds removed from your account that are not excess contributions face penalty and tax.

The IRS is firm on the fact that once funds go into the HSA account, they are to be used for medical purposes. Besides excess contribution correction, any removal of funds from the account are considered “Non Qualified Deductions”. Per IRS 696:

HSA-non-qualified-distribution-tax-and-penalty

Note that the above text “not used for qualified medical expenses” is incredibly broad. It includes any sort of scenario, other than removing excess contributions, where HSA funds are coming out of your HSA and not being spent on qualified medical expenses. This comes up often from readers as they assume they have flexibility to contribute / distribute from the HSA as they see fit. The IRS does not agree, and once the money goes in, it is not easy to just take out. Thus, care and planning should occur for calculating how much to contribute to your HSA during a year.

Calculating Non Qualified Distribution Penalty

Removing funds from the HSA not spent on medical expenses is costly. If this applies to you, see our article “Can You Cash Out An HSA?” for options on getting the money out.

If the penalty is indeed due, you will need to pay both tax and penalty on the amount. This sort of makes sense – the IRS is 1) undoing the tax benefit you got from the initial contribution and 2) penalizing you for not following the rules. This assessment occurs in Part 2 of Form 8889 under “HSA Distributions”. Here is what that section looks like:

Form-8889-HSA-Distribution-Penalties-and-tax

As you can see above, assume you have a non qualified or “excess” distribution that came out of your HSA. #1 indicates where your non qualified distribution is added to income and is taxed. #2 indicates where the 20% penalty is calculated and added to your tax bill due.

Overall, it is an expensive way of getting your money out. Plan accordingly.

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

Short Term Investment Tax Implications for HSAs

This question was sent in by HSA Edge reader Marc. Feel free to send in your own question.

What is the tax consequence for holding an investment through an HSA brokerage account for a short term? Iknow that HSAs are tax free if you obey the rules of the HSA, so I’m assuming there’s nothing limiting the length of time held in an investment?

Tax Free Growth

You are correct that there is nothing that limits or penalizes investment length in the HSA. As part of the HSA’s triple tax advantage, investments grow tax free. This means that capital gains, either short or long term, are not assessed on any growth in the HSA. Per IRS Form 969:

The interest or other earnings on the assets in the account are tax free

In a non-tax advantaged (regular “brokerage”) account, a tax liability is created when earnings occur from buying and selling a financial instrument. The rate of those capital gains is determined by how long the investment is held. That amount must be aggregated at tax time and paid, with any losses offsetting taxes on gains. This is not the case with an HSA, and this is a benefit to the user in terms of:

long term growth
tax savings
reduced paperwork

Thus, the HSA can be used as a “trading vehicle” without penalty, although the risk of that strategy is up to the account holder to decide.

FYI Fidelity recently started offering HSA’s with no fees and very good investment options.

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

Who Needs to File Form 8889?

In order to take advantage of the many tax benefits of Health Savings Accounts, there is a tax reporting requirement that occurs each year. When you file your taxes via TurboTax, H&R Block, etc., you are required to report HSA information on Form 8889, the IRS tax form for HSA’s. It is a slightly annoying, overly-engineered two page tax form that is required for those with transactions in their HSA during the year. As you will see, there are multiple scenarios that can cause confusion on who needs to file this form. Hopefully we address them all and provide clarity on your situation.

HSA Transactions require Form 8889

You need to file Form 8889 for the year if transactions occurred in the HSA. What are transactions? These include:

Contributions made to HSA
Distributions from HSA
Penalties for failing testing period
You acquired HSA due to death of beneficiary

If any of those apply to your HSA this year, you need to file Form 8889 with your taxes. On the other hand, if your HSA sat idle during the year, you do not need to file Form 8889. A common example of this is you 1) no longer have HSA eligible insurance, so are not contributing to the HSA and 2) you did not make any distributions from the HSA this year. If you make distributions (or contributions) in the future, you would file the form with that tax year.

Preparing Form 8889 for family coverage

To summarize who needs to file Form 8889:

File Form 8889 for each person with a Health Savings Account that had transactions during the year.

Notice the “each person with a Health Savings Account” part. This means each person with a Health Savings Account; you know, like a bank account that exists at a financial institution. If both you and your spouse have a Health Savings Account, and you made contributions or distributions to either during the year, you each need to file separate Form 8889’s.

This is important because Form 8889 reflects the tax benefits (and penalties!) associated with the HSA itself. For a family with 2 HSA’s, the two Form 8889’s will total your combined activity for the year. For example, a $6,900 contribution limit resulted in $3,000 contributed to HSA 1 and $3,900 was contributed to HSA 2, etc. Both of these need to be reported.

Why do you need to file 2 Form 8889’s in that scenario? It is because of the magic “Line 6” split for married couples with separate HSA’s.

Spouses who have separate HSA’s and family coverage “split” the contribution limit.

This means that with family coverage and 2 HSA’s, each HSA is receiving an allocation of the HSA contribution limit. While you are allowed to make this allocation however you want (save for the 55+ catch up contribution), each HSA receives an allocation. The result is you cannot file one Form 8889 and capture the tax implications, as even “$0” needs to be reported.

Form-8889-Line-6-family-hsa-contribution-split

[Note: the Line 6 split is especially complicated. If you don’t want to read the 1+ pages of IRS instructions, have EasyForm8889.com take care of it for you.]

Below is a review of common scenarios and how Form 8889 must be filed.

1) What if my spouse and I have family coverage?

If you were on family coverage during the year, you need to file Form 8889 for each HSA that existed and had transactions. If only you have an HSA, and the full contribution limit went into it, you only need to file one Form 8889 reporting those transactions. On the other hand, if both you and your spouse have an HSA, and you split the contribution limit per Line 6, you both need to file a Form 8889.

2) What if my spouse has their own HSA?

If your spouse has their own HSA, you will need to file a Form 8889 for it. Again, this assumes transactions occurred in the HSA during the year. Alternatively, if the HSA just kind of sat there, and no contributions nor distributions occurred, you do not need to file Form 8889 for it.

3) What if my adult child has their own HSA?

A nice loophole of HSA’s is that adult children on family coverage can open their own HSA. This allows them (or you, or others) to fund a substantial amount each year. The minor downside here is they will need to file a Form 8889 for each year transactions occur. So this is an additional form to file, potentially a 3rd (or 4th!) if both spouses have an HSA.

4) What if my spouse is 55 or older?

One specific rule about the 55+ catch up contribution of $1,000 is that it must follow the person who is over 55. This means that if you are over 55, and you want to take advantage of the 55+ contribution, the $1,000 needs to go into your HSA. You cannot place your $1,000 into your partner’s HSA.

For example: say the husband is 56 years old on family coverage but the insurance and HSA are in the wife’s name. His $1,000 cannot go into her HSA. Instead, the husband needs to open his own HSA and contribute the $1,000 (and any Line 6 “split” of the family contribution limit) there.

5) What if my spouse and I are both 55 or older?

As you might guess from the previous scenario, each spouse who is over 55 needs their own HSA if they are going to take advantage of the 55+ contribution. For couples on family coverage who are both over 55, this means you need 2 HSA’s to fully maximize your contribution. This maximum would equal the family contribution limit plus $1k for spouse and $1k for other spouse. Opening the HSA should not cost you anything. It is a little annoying to file the additional Form 8889, but this is the only way to maximize your 55+ contribution for the year.

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