HSA Mistaken Distributions and How to Correct Them
By Debbie Shipman, CIS, CIP, CISP, CHSP
As health savings accounts (HSAs) become more popular, questions about how to correct errors also increase. One question financial organizations often receive is, “is this a mistaken distribution?”
Six months ago, my client took a $300 distribution from her HSA to pay for a qualified medical expense not fully covered by her insurance. Yesterday in the mail, she received a $200 reimbursement check from her insurance company because insurance covered more than she originally expected. She wants to return the $200 to her HSA. Is that a mistaken distribution?
In Internal Revenue Bulletin 2024-33, Q&A 37, the IRS states, “if there is clear and convincing evidence that amounts were distributed from an HSA because of a mistake of fact due to reasonable cause, the account beneficiary may repay the mistaken distribution no later than April 15 following the first year the account beneficiary knew or should have known the distribution was a mistake.”
Financial organizations are not required to accept returns of mistaken distributions (IRS Notice 2004-50, Q&A 76). If your organization allows the return of a mistaken distribution, you may rely on the HSA owner’s representation that the distribution qualifies. Your financial organization should not report the transaction on IRS Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, or IRS Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA Information. If the mistaken distribution was already reported on Form 1099-SA, your financial organization should issue a corrected Form 1099-SA.
When an HSA owner has a mistaken distribution, the amount being returned through the mistaken distribution rules is not included in gross income, nor is it subject to the additional 20 percent penalty tax.
My client mistakenly used his HSA debit card at the grocery store and a restaurant last week. He is in our financial organization today and wants to fix it by returning the same amounts to his HSA. Is that a mistaken distribution?
While it was a mistake that he used his HSA debit card for groceries and dining, it is not a “mistaken distribution” according to the IRS definition. The HSA owner has two options.
He can roll over one or both HSA debit card distributions no later than 60 days following the date of the distribution, provided he also meets the one-per-12-month rule. That is, one year must pass from the date of the rollover contribution to the HSA before the HSA owner is eligible for another rollover contribution. Unlike with an IRA, the HSA one-per-12-month rule limits the number of contributions, not the number of distributions.
If there are HSA qualified medical expenses that he has paid out-of-pocket, he could keep the distribution amounts and report them on IRS Form 8889, Health Savings Accounts (HSAs), as qualified medical expense distributions, which are tax- and penalty-free.
