As mentioned, the IRS provides two ways of correcting over-contributions. The first involves removing the excess from the account in the tax year that it occurred. This means you have until your tax due date to make the correction. You must also remove any earnings on your excess contributions. The second method involves applying your HSA excess contributions to the following year.
Removing Excess Contributions
For most people, the removal method will be the preferred option. It is relatively simple to do, and it takes care of the problem once and for all. It allows you to avoid paying a penalty as long as three criteria are met. You must:
- Withdraw the excess contributions no later than the due date of your tax return for the year the contributions were made. These withdrawals will be considered taxable income.
- Take out any income earned on the withdrawn contributions during the year they were made. This will also be taxable income.
- Include the earnings in “Other Income” on the tax return for the year you withdraw the contributions and earnings.
You can withdraw some or all of the excess contributions, but you will have to pay the excise tax on any that you leave in the account.
When removing excess contributions from your account, you must inform your HSA trustee; otherwise they won’t know to do it. The excess funds that were withdrawn will be listed on Form 1099-SA as a distribution, in Box 1, for the tax year in which the distribution was taken. Earnings on excess contributions withdrawn will be in Box 2 and included in Box 1. Form 5498-SA will report the market value of your HSA at the end of the calendar year, the total contributions made within the calendar year, and the total contributions for the tax year through the tax filing deadline, typically April 15. The account owner should retain Form 5498-SA for record keeping purposes, but is not required to submit it to the IRS.
Future Year Option
The second way to avoid the HSA excess contributions penalty is through the “future year method.” It involves deducting some or all of your HSA excess contributions and applying them to a future year. The IRS does not allow you to apply more than you have in excess. It’s also important to keep in mind that moving the excess to the following year counts towards the future year’s annual contribution limit.
The future year method is more complicated than the removal method, especially if you have earnings from any of the excess contributions. If you opt to roll forward some, but not all, of the excess contributions, you will owe the 6 percent tax on any that are not applied to a future year. Both methods must be completed before your tax filing deadline or you will be charged the excise tax. Consider filing an extension on your taxes to give you more time.
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