Knowing When Not to Report HSA Transactions
By Jennifer Bassett, QKA, CIP, CISP, CHSP
A major area of compliance in offering and maintaining health savings accounts (HSAs) is accurately reporting HSA transactions. Incorrectly reporting HSA transactions may cause the IRS to pay more attention to your organization (and not in a good way). To prevent being audited and potentially penalized by the IRS, it’s important that you and your staff understand the HSA reporting requirements—including when not to report certain transactions.
Certain Excess Contributions
According to IRS Notice 2008-59, Q&A 24, if an employer erroneously contributes more than the statutory limit ($3,500 for self-only coverage and $7,000 for family coverage, for 2019) to an employee’s HSA, the employer may ask the financial organization to return (i.e., recoup) the excess amount with the net income attributable (NIA). The employer has until the end of the tax year in which it made the contribution to recover the ineligible or excess amount. The 2019 Instructions for Forms 1099-SA and 5498-SA indicate that financial organizations must suppress the reporting of the contribution and subsequent distribution.
If the employer fails to recover the amount by the end of the tax year, then
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 employer made the contribution, or
the employee must report the excess amount as “Other income” on his tax return.
Example: The Sweet Life Bakery made HSA contributions to all of its eligible employees in January 2019. In July 2019, the bakery’s owner discovered that it accidentally contributed $4,000 to one of its employees (Ted Adams) who only had self-only coverage during 2019. Once it discovered the error, the bakery asked the financial organization holding Ted’s HSA (SkyBlue Credit Union) to return the $500 excess contribution and NIA. The credit union returned the excess contribution and NIA to the bakery in August 2019. The credit union did not report the initial deposit of the $500 excess contribution or the subsequent distribution. Because the excess contribution was returned to the bakery before the end of its 2019 tax year, the bakery does not have to include the $500 excess on Ted’s 2019 Form W-2.
An employer may recover contributions in other situations as well. In the past, an employer’s ability to recoup HSA contributions was believed to be limited by the guidance contained in IRS Notice 2008-59. Then in late 2018, the IRS released Information Letter 2018-0033, which contains an expanded list of circumstances under which an employer may recoup HSA contributions transmitted to a custodian or trustee.
A mistaken distribution occurs when an HSA owner takes a distribution to pay for what she mistakenly believes is a qualified medical expense. The HSA owner may “correct” the mistake by returning the distributed assets to the HSA and acting as if the distribution had not occurred.
Your organization is not required to accept returns of mistaken distributions. IRS Notice 2004-50 explains that financial organizations that do accept mistaken distributions may rely on the HSA owner’s representation that the distribution was a mistake. The deadline for repaying a mistaken distribution is April 15 following the first year the HSA owner knew or should have known that the distribution was a mistake.
Example: On May 9, 2019, Fred Jones takes a $200 HSA distribution to pay for a pair of prescription sunglasses. Fred later finds out that he did not need to take an HSA distribution because prescription sunglasses are covered under his vision plan. Fred is reimbursed by his insurance company on July 1, 2019. He then asks to move $200 from his checking account into his HSA at ABC Bank. ABC Bank accepts the return of the mistaken distribution and moves $200 into Fred’s HSA. ABC Bank does not report the $200 distribution on the 2019 IRS Form 1099-SA and instead uses a nonreportable transaction code—i.e., a transfer code—to deposit the $200 into the HSA.
Note that in the case of a mistaken distribution that has already been reported on Form 1099-SA, the financial organization should issue a corrected Form 1099-SA.
Possible Nonreportable Transactions
Like other types of accounts, HSAs can be a target for fraudulent activity. Clients may suddenly find themselves unsuspecting victims of illegal, unauthorized transactions. Because the IRS has yet to release official guidance on this issue, your organization should create and follow its own internal procedures for handling fraudulent HSA transactions. When fraudulent activity occurs, make sure your organization’s legal counsel is aware of the issue and agrees with any steps taken after the activity is identified.
Example: In February 2019, Piper Smith’s HSA debit card was stolen and $900 was illegally taken from her HSA. In August 2019, Piper was reimbursed for the money that was stolen from her HSA. She asks Greenway Bank to redeposit $900 into her HSA. After gathering proof (such as police reports, account activity reports) that $900 was illegally taken from Piper’s HSA, Greenway Bank’s legal counsel and management agree to use a nonreportable transaction code to deposit the money back into Piper’s HSA. The bank also suppresses the distribution reporting. Greenway Bank will keep detailed notes—including steps taken to verify that the money was illegally distributed—in Piper’s HSA file.