Correcting HSA Mistaken Distributions
By Jodie Norquist, CIP
My client took a $500 distribution from his HSA to pay for a medical expense. Later, he discovered that his high deductible health plan covered more of his medical expenses than he anticipated, so he ended up only owing $200 for this qualified medical expense. He now wants to return $300 to the same HSA. Can he do that?
In IRS terms, if there is “clear and convincing” evidence that the distribution was taken because of a “mistake of fact due to reasonable cause” (a “mistaken distribution”), then your client may repay the distribution by his tax return due date—typically April 15—following the year he knew or should have known that the “mistaken distribution” occurred. In many situations, a health savings account (HSA) owner may reasonably believe that an out-of-pocket medical expense was a qualified medical expense and reimburse himself from the HSA for the expense, only to discover later that the expense was covered by insurance or otherwise considered a nonqualified medical expense.
Under these circumstances, the distribution is not included in the gross income under Internal Revenue Code Section (IRC Sec.) 223(f)(2), or subject to the 10 percent additional tax under IRC Sec. 223(f)(4), and the repayment is not subject to the excise tax on excess contributions under IRC Sec. 4973(a)(5).
While your financial organization is not required to accept returns of mistaken distributions (see Notice 2004-50), if you do accept these monetary returns, you may take the HSA owner at his word that the distribution was, in fact, a mistake.
When the situation meets the IRS’ definition of a mistaken distribution, your financial organization should not report the transaction. According to the Instructions for Forms 1099-SA and 5498-SA, you do not report the distributed amount, nor contributed amounts to the IRS. Mistaken distributions that are timely corrected by the HSA owner are considered nonreportable transactions. If the mistaken distributions have already been reported on Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, your financial organization should issue a corrected Form 1099-SA.
My client mistakenly used her HSA debit card twice while dining out on vacation last month. She just called our financial organization and wants to fix this. Is this considered a mistaken distribution? What can she do?
As more consumers open HSAs to help offset healthcare costs and insurance premiums, you may see an increase in questions from clients on how to correct all types of HSA errors. While this situation is a common error we hear about from financial organizations, it would not be considered a “mistaken distribution” according to the IRS’ definition.
In this case, your client has the following options.
Recontribute one or both of the HSA debit card withdrawals in one rollover contribution no later than 60 days following the distribution. The one-per-12-month rollover rule applies, but that limitation restricts the number of contribution events, not the number of distributions; furthermore, HSA rollovers are not aggregated with IRA rollovers under this limit.
Keep receipts that show she previously paid out-of-pocket medical expenses not covered by health insurance that would be considered qualified medical expenses if she had used her HSA to pay for them. With this option, she would not have to recontribute her distributions to her HSA.
HSA owners are ultimately responsible for determining whether distributions are qualified or nonqualified, and if they need to return mistaken distributions to their HSAs. A 20 percent penalty tax may be applicable for nonqualified medical expenses. HSA owners report these distributions on IRS Form 8889, Health Savings Accounts (HSAs).
