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I contributed to HSA for the year 2016 but , now 2018, I found out my HDHP is not eligible for HSA, What should I do now?.

Forum|Forum|7 years ago
June 5, 2019
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In January of 2017, I opened a private HSA account at a local credit union and contributed the maximum amount allowed for the 2016 tax year, because I thought my HDHP was eligible for an HSA account. Now it's 2018 and I have not contributed any further amount to the HSA and now I just found out I was not eligible for the HSA. What should be my next step? What are my options? should I contact the credit union and convert the HSA account to something else? should I amend my 2016 tax return to include the contribution as income?

Best answer by dmertz

Because only HSA-eligible individuals are permitted to open an HSA, if you were never an HSA-eligible individual, the account that you opened does not qualify as an HSA; no HSA exists. (IRS Notice 2008-59 Q&A-23) If this is your situation, the HSA administrator has a special procedure for dealing with this, so contact the HSA administrator and explain that you were never an HSA-eligible individual.

Because the account never qualified as an HSA and no HSA exists, the deposit did not constitute an HSA contribution. Because the deposit did not qualify as an HSA contribution, you are not subject to any excess contribution penalties. You must amend your 2016 tax return to remove the reported HSA contribution and include income the amount deposited, either by removing the deduction on Form 1040 line 25 or, if the contribution was through your employer and reported with code W in box 12 of your W-2, by including the amount deposited as miscellaneous income on Form 1040 line 21.

The special procedure followed by the HSA custodian will likely treat the account as a regular savings account. If there has been any gain in investment value, you'll likely be subject to income tax on the gain.

D

dmertzAnswer

Employee

Because only HSA-eligible individuals are permitted to open an HSA, if you were never an HSA-eligible individual, the account that you opened does not qualify as an HSA; no HSA exists. (IRS Notice 2008-59 Q&A-23) If this is your situation, the HSA administrator has a special procedure for dealing with this, so contact the HSA administrator and explain that you were never an HSA-eligible individual.

Because the account never qualified as an HSA and no HSA exists, the deposit did not constitute an HSA contribution. Because the deposit did not qualify as an HSA contribution, you are not subject to any excess contribution penalties. You must amend your 2016 tax return to remove the reported HSA contribution and include income the amount deposited, either by removing the deduction on Form 1040 line 25 or, if the contribution was through your employer and reported with code W in box 12 of your W-2, by including the amount deposited as miscellaneous income on Form 1040 line 21.

The special procedure followed by the HSA custodian will likely treat the account as a regular savings account. If there has been any gain in investment value, you'll likely be subject to income tax on the gain.

K

khoidtranAuthor

Thank you for the answer and link to the publication, it helps. However, my HSA custodian cannot change HSA account to other type and don't know protocol for reporting to IRS about this situation of error. They would only provide withdrawal form and to mark reason for withdrawal. List of reason has nothing about mistaken contribution or open account in error or anything related. The only option that seems good is withdrawal of excess contribution after deadline, which will give report form 1099-SA with code 2. Is this the right option to report to IRS by bank? Thank you

J

J81

Your HSA custodian cannot convert a health savings account into a traditional savings account. This is not a thing. So long as the account has funds in it, a yearly tax form will generate showing the value, plus any contributions made for the corresponding tax year of the form.
The fix depends on whether it is corrected within the deadline of the tax year the contribution was made, or if that time has passed.

Within deadline: If your employer sponsors the account and contributes pre-tax out of payroll, hit them up first. Your custodian can provide them a form to return the funds back to payroll to be taxed. Most employers will not bother with the hassle, but I see many do it each year and the worst thing that can happen is being told no. If they are not willing to do this, you will need to do a Return of Excess Contribution form.

Outside of deadline: Anything outside of the deadline for the corresponding tax year will have to be corrected by a Mistaken Contribution form. If there are more than one tax year involved, I suggest doing a separate form for each tax year, even if the custodian’s form allows for more than one tax year on the same form. I won’t deep dive into why the extra hassle is worth it, but I’ll sum it up by saying it involves a higher potential for human error that can take things from level nuisance to outright maddening.

How corrections are reported: This ultimately depends on the method of correction.
Employer: If corrected within deadline and before original Form W2’s are sent, no reporting necessary. They will simply put the correct info on your Form W2. (Most unlikely scenario, unfortunately.) If corrected within deadline, but after original W2’s have been sent, they will need to do a corrected Form W2, in addition to the correction with the custodian.

Return of Excess Contribution Form: This will generate two Form 5498’s, the original and the corrected.
Mistaken Contribution Form: This will generate a corrected form for each tax year applicable.

Callouts:

Corrected Form 5498 will look almost exactly like the original. Look closely for the checked “Corrected” box.
Adjust your expectations, this is a hassle no matter how you go about it.
Expect the possibility of having to do the same form twice. (Depending on the form.) Round 1 informs the amount and the tax year to the custodian. Round 2 includes any applicable interest that cannot be calculated without the information from round 1, resulting in a slightly different (but correct and official) dollar amount. Since your John Hancock is required to both inform the custodian, and for your custodian to make it official, just go in with the expectation that you might be told to repeat the same form with the new dollar amount from calculated interest.
If you spent the funds that should have never been contributed in the first place, pull up your drawers and take a deep breath—you just leveled up to more forms, time, hassle, and parting with money for some time. You will need to do a Mistaken Distribution form and repay your HSA before the correction process can even begin. There is no way around it.
Lastly, it’s important to know that HSA’s are owned by you and regulated by the government. Your employer, broker, or even your HSA custodian hold no legal responsibility for any consequences resulting from money moving in or out of the account in a way that violates regulation. HSA’s are the only triple tax advantaged accounts that exist. Their long-term benefits and flexibility of use put a 401k to shame and send FSA’s hiding under their blankets of custodian-required receipts—but they are still governed by the IRS and should be opened and used only after one does their homework.

I hope this helps!

A

Anonymous

yes, you need to amend 2016 return by not taking the deduction and including form 5329 to pay the 6% excise tax

you need to amend 2017 to pay the excise tax for that year because the excess remained.

you need to withdraw the money in the HSA before 12/31/18 to avoid the 6% tax for that year. even if you do. any income earned by the HSA must be included as other income on your 2018 return

Here's what IRS Publication 969 has to say about the excess contributions (contributions in excess of what is allowed):

Generally, you must pay a 6% excise tax on excess contributions. See Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, to figure the excise tax. The excise tax applies to each tax year the excess contribution remains in the account.

Any excess contribution remaining at the end of a tax year is subject to the excise tax. See Form 5329.

You also must withdraw any income earned on the withdrawn contributions and include the earnings in “Other income” on your tax return for the year you withdraw the contributions and earnings.