Removing HSA Excess Contributions
By Christle Johnson, QKA, CIP
When a health savings account (HSA) receives ineligible contributions or ineligible rollovers, it results in an HSA excess contribution, which—when they become aware of it—may lead to questions from your HSA clients about how to correct or remove the excess. Before you help clients address this issue, a basic overview of how to remove and report excess contributions may be helpful.
An excess HSA contribution occurs if aggregate amounts received by the HSA exceed the HSA owner’s eligible contribution limit for the year. Excess contributions that are not removed by the HSA owner’s tax return due date, including extensions, subject the HSA owner to an additional six percent penalty tax for each year the excess remains in the HSA.
Excess Employer Contributions
If an employer erroneously contributes more than the statutory limit to an employee’s HSA—based on the annual contribution limit or employee eligibility—the employer is entitled to request that the financial organization return the excess amount with the net income attributable (NIA) to the employer. The NIA is a pro rata portion of the net income earned on all assets in the HSA (whether positive or negative) during the period that the HSA held the excess contribution. Treasury regulations provide the requirements for calculating NIA, but an excess removal form, such as the Ascensus® IRA or HSA Excess Removal Worksheet, can be used to more easily calculate the NIA.
The employer has until the end of the tax year in which it made the contribution to recover the ineligible or excess amount. If the contribution is returned to the employer, the HSA trustee or custodian should suppress the reporting of the contribution and the subsequent distribution.
If the employer does not recover the amount, the employer must include the excess amount as wages in Box 1 of the employee’s Form W-2, Wage and Tax Statement, for the year in which the contribution was made. In this situation, the HSA owner still has an excess contribution and should remove it to avoid additional IRS penalty taxes.
Removing the Excess Before the Deadline
If the HSA owner removes the excess amount with NIA by his tax return due date, plus extensions—generally October 15—he will avoid the six percent penalty tax.
When removing excess contributions before this deadline, HSA owners must remove any NIA amount and include it in taxable income.
Although the HSA owner bears the burden for providing the necessary information to report the removal of an excess contribution, HSA trustees and custodians often help determine the amount that the HSA owner must withdraw to correct an excess contribution, as they generally will have all of the information necessary to determine the NIA.
Financial organizations must report the distribution of excess contributions on Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, but they should not reduce the contribution amounts reported on Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA Information; one offsets the other.
The total distribution (excess and NIA) is reported in Box 1, Gross distribution, on Form 1099-SA and only the NIA is reported in Box 2, Earnings on excess contribution. To indicate that the distribution is the removal of an excess contribution, code 2, Excess contributions, must be entered in Box 3. The Form 1099-SA instructions indicate that HSA owners must include the NIA distributed with the excess as income for the year the distribution is received.
If the distribution of an excess contribution occurs in the same year that other distributions are made, financial organizations must report the distribution of the excess on a separate Form 1099‑SA.
Removing the Excess After the Deadline
If the HSA owner does not remove the excess by her tax return due date, plus extensions, she will have to pay a six percent penalty tax on the excess contribution amount for each year that an excess remains in the HSA. An HSA owner may still remove an excess contribution after the her tax return due date plus extensions—or carry it forward as a contribution for a future year—but does not remove the earnings.
In addition to paying the six percent excess contribution penalty tax, the HSA owner must include the distribution of the excess contribution in income for the year of the distribution if not used for qualified medical expenses. IRS guidance is unclear, but it appears that HSA owners who remove excess contributions after their tax filing deadlines and do not use them for qualified medical expenses may also be subject to the additional 20 percent penalty tax (unless an exception applies). HSA owners should seek advice from competent tax advisors to be sure they pay the required taxes when filing their income tax returns.
When removing an excess after the October 15 deadline, financial organizations must report the excess amount removed in Box 1 of Form 1099-SA and leave Box 2 blank. The appropriate distribution code for the recipient (code 1, 3, 4, or 6,) must be entered in Box 3.
The rules for dealing with HSA excess contributions and their reporting are likely to be less familiar to custodian and trustee organizations than the IRA excess contribution rules, but the principles are sufficiently similar.
