A Health Savings Account (HSA) is a great way to provide yourself with medical coverage. These are created through a company, and contributions are typically made manually or automatically through pre-tax withdrawals from your paycheck. However, these contributions have an annual limit on how much can be added to your account. In 2022, an individual plan had a maximum contribution limit of $4,650 and families have a limit of $7,300. There are also special allowances for those who are only eligible for part of the year, those over 55, and those who fall under other special circumstances. For instance, if both spouses are 55 and not enrolled in Medicare, each spouse’s contribution limit is increased by the additional contribution. If both spouses meet the age requirement, the total contributions under family coverage can’t be more than $9,300. Each spouse must make an additional contribution to its own HSA. So, what happens when contributions are made over the yearly limit? Depending on if the proper steps are taken or not can affect what happens next. A withdrawal must take place, but fees may also be assessed. To truly ensure you are taking the proper steps, it is imperative to talk to your accountant and HSA custodian to avoid any penalties or future complications.
When looking at excess contributions made to the HSA, it is important to take corrective measures before the end of the calendar year. Or, at latest, the end of the tax filing season. If action isn’t taken before the end of the tax season, then an excise tax of 6% can be assessed. Depending on who made the excess contribution and when the excess contributions are corrected will determine the steps that need to be taken.
Correcting the Issue
HSAs are commonly contributed to by the employee and the employer. Employers will generally match or contribute a percentage of what the employee contributes out of their payroll. Earnings contributed to the account will then accumulate interest. If an over payment is made, first, the employer or the employee must begin correcting the account by contacting the HSA custodian. Then, depending on when the error was caught and who made the excess contributions, the course of action needed to amend the HSA will be established.
- If the error is caught before the end of the year, the distributions will be made accordingly, and the employer will include these as earnings on the employee’s W2. When distributions are made, the amount credited to the employee must be adjusted for interest earned on the account as well. Payroll taxes will be applied to the contributions, but not to the interest earned.
- On the occasion that the mistake is caught after the end of the calendar year, the contribution will still need to be included as gross income for the employee to be taxed appropriately, so the employer will need to issue a corrected W2c with the excess contributions included. This may also entail the employee filing an amended tax return depending on if the employee’s income tax was filed for the year or not. If an amended tax return is filed, “Filed Pursuant to section 301.9100-2” needs to be written at the top with an explanation of why the amendment was necessary.
- When employees make contributions outside of their employer’s payroll that cause the excess, then it is the sole responsibility of the employee to contact their HSA custodian to correct the excess amounts. This is commonly an issue when employees change employment mid-year or both spouses contribute to the HSA.
- Occasionally, excess contributions that do not exceed the limit are made by accident. In this situation, the employer must get in contact with the HSA custodian and provide proof of administrative and clerical errors causing the excess contribution. The IRS outlines the ability of the HSA custodian to return the funds.
For Example
Emily is single and has a Health Savings Account for medical coverage. At the end of the year, it was discovered that $3,950 had been contributed to her HSA through the year. Thus, her HSA has an excess contribution amount of $350. Emily had made the excess contribution without thinking of the yearly limitations.
To fix Emily’s HSA, the $350, along with accumulated interest, must be distributed back to Emily. The original contribution must be adjusted to show the $350 as income, taxed (interest earned is not taxed), and both the contribution and interest are included in her W2.
However, if the mistake was not accounted for until after the new year, a corrected W2c must be created for Emily showing the adjusted income of $350 as well as the earnings accumulated. If Emily has already filed her taxes for the prior year, then she must file an amendment showing the adjustment and, if applicable, a 6% excise tax.
In both situations, Emily must work with the HSA custodian to receive distributions from the excess contribution. If she does not co-operate to receive the distributions and the tax filing deadline passes, then she will have to pay the 6% excise tax.
Reaching Contribution Limits
When limits are reached for HSAs, the employer must stop contributions to their account. Employers must not knowingly contribute excess amounts to an employee’s HSA. Distributions with earnings must be made to correct the excess amount by April 15th, or October 15th if an extension for filing was applied for, or a 6% excise tax will then be owed. This fee will be assessed every year that the excess amounts are in the HSA.
Furthermore, overpayments and their distributions will be reported on line 14b of Form 8889 and in Box 3 of Form 1099-SA, which is provided by the HSA custodians. The IRS has a rule pertaining to Form 8889 allowing for up to six months after the date of the return to receive the distributions. If applicable, form 5329 reports the 6% excise tax on excess amounts not withdrawn. Distributions will be included in the tax year that the distributions are received, even if the contribution was initially made in the previous tax year.
The rules and regulations for HSA contributions and how to handle excess contributions change frequently. That is why consulting with your accountant and HSA custodian is key to your financial success. You can contact Kislay Shah CPA to guarantee that you have the best advice to make the right choices to maximize your HSA and minimize fees that could harm your finances.