By Brian Gilmore | Published April 6, 2021
Question: How should employers and employees address mistaken HSA contributions in excess of the statutory limit?
Short Answer: Employers can work with the HSA custodian to return excess contributions made through their payroll, but any other excess contribution will require the employee to take a corrective distribution directly from the HSA custodian.
General Rule: HSA Statutory Limit
The HSA contribution limits are adjusted annually for inflation, currently at the following levels:
2021 Contribution Limits
For more details on everything HDHP/HSA, see our Newfront Go All the Way With HSA Guide.
Excess HSA Contributions through Employer’s Payroll: Employer Correction Process
If an employer contributes to an employee’s HSA in excess of the statutory limit, the employer can correct the error before the end of the calendar year by requesting that the HSA custodian return the excess contributions (adjusted for earnings) back to the employer.
Assuming the HSA custodian agrees to return the excess funds, the employer should process the correction as follows:
If the employer fails to recover the excess contributions from the custodian by the end of the calendar year, the excess contributions will need to be included as gross income on the employee’s Form W-2 for the year in which the employer made the contributions. This may require the employer to issue a corrected Form W-2c to the employee. Furthermore, the employee would need to take a corrective distribution of the excess funds by the tax filing deadline (generally April 15 without extension, delayed this year to May 17, 2021) to avoid a 6% excise tax owed on the excess contributions.
Example 1:
Result 1:
Example 2:
Result 2:
Excess HSA Contributions Outside of Employer’s Payroll: Employee Corrective Distribution
Where an employee has excess contributions that were not made through the employer’s payroll, the excess contributions are purely an individual income tax issue. There is no employer role in the correction process because the employer was not responsible for excess. The corrections are therefore handled directly by the employee in coordination with the HSA custodian.
Examples of where excess contributions may occur outside of the employer’s payroll include:
Even though a portion of the HSA contributions may have been employer/employee contributions through payroll, those contributions through payroll by themself did not create the excess. Accordingly, the employer does not have a basis to take corrective action.
Corrective Distribution by Tax Filing Deadline
To avoid a 6% excise tax on the excess contributions, the employee must work directly with the HSA custodian to take a corrective distribution of the excess contributions, adjusted for earnings. The earnings portion of the corrective distribution is included in the employee’s gross income, but there are no additional taxes. In other words, neither the 6% excise tax nor the 20% additional tax for non-medical distributions will apply.
The general rule is the employee must take the corrective distribution by the tax filing deadline (typically April 15, delayed this year to May 17, 2021), or the later deadline if filing for an extension (typically October 15), to avoid the 6% excise tax. The corrective distribution is reported on Line 14b of the Form 8889 filed with the individual income tax return. It is also reported as an excess contribution distribution (Code 2) in Box 3 of the Form 1099-SA provided by the HSA custodian.
There is a special rule outlined in the IRS Form 8889 Instructions providing individuals the opportunity to take a corrective distribution up to six months after the due date of the return, including extensions. Under that special rule, employees can work with their personal tax advisor to file an amended return with the statement “Filed pursuant to section 301.9100-2” entered at the top. This may also require additional changes to the Form 5329 to reflect that the corrective distribution will avoid the previously applicable 6% excise tax.
The 6% Excise Tax
Employees failing to take a corrective distribution from the HSA custodian will need to report the excess contributions as subject to the 6% excise tax reported on IRS Form 5329. They will continue to pay the 6% excise tax each year until the excess contributions are distributed.
Example 3:
Result 3:
Mistaken HSA Contributions Not Exceeding Statutory Limit: Employer Administrative or Process Error
Where an employer mistakenly contributes too much to an employee’s HSA, but those contributions do not exceed the statutory limit, a recent IRS Information Letter outlines the ability of employers to correct the error by requesting the HSA custodian return the mistaken contributions back to the employer. This approach is available where there is clear documentary evidence demonstrating that there was an administrative or process error made by the employer.
For more details on everything HSA, see our Newfront Go All the Way With HSA Guide.
Regulations
(3) Excess contributions returned before due date of return.
(A) In general. If any excess contribution is contributed for a taxable year to any health savings account of an individual, paragraph (2) shall not apply to distributions from the health savings accounts of such individual (to the extent such distributions do not exceed the aggregate excess contributions to all such accounts of such individual for such year) if—
(i) such distribution is received by the individual on or before the last day prescribed by law (including extensions of time) for filing such individual’s return for such taxable year, and
(ii) such distribution is accompanied by the amount of net income attributable to such excess contribution.
Any net income described in clause (ii) shall be included in the gross income of the individual for the taxable year in which it is received.
(a) Tax imposed.
a health savings account (within the meaning of section 223(d)), or
there is imposed for each taxable year a tax in an amount equal to 6 percent of the amount of the excess contributions to such individual’s accounts or annuities (determined as of the close of the taxable year). The amount of such tax for any taxable year shall not exceed 6 percent of the value of the account or annuity (determined as of the close of the taxable year). In the case of an endowment contract described in section 408(b), the tax imposed by this section does not apply to any amount allocable to life, health, accident, or other insurance under such contract. The tax imposed by this subsection shall be paid by such individual.
IRS Notice 2004-2:
Q-22. What happens when HSA contributions exceed the maximum amount that may be deducted or excluded from gross income in a taxable year?
A-22. Contributions by individuals to an HSA, or if made on behalf of an individual to an HSA, are not deductible to the extent they exceed the limits described in A-12. Contributions by an employer to an HSA for an employee are included in the gross income of the employee to the extent that they exceed the limits described in A-12 or if they are made on behalf of an employee who is not an eligible individual. In addition, an excise tax of 6% for each taxable year is imposed on the account beneficiary for excess individual and employer contributions.
However, if the excess contributions for a taxable year and the net income attributable to such excess contributions are paid to the account beneficiary before the last day prescribed by law (including extensions) for filing the account beneficiary’s federal income tax return for the taxable year, then the net income attributable to the excess contributions is included in the account beneficiary’s gross income for the taxable year in which the distribution is received but the excise tax is not imposed on the excess contribution and the distribution of the excess contributions is not taxed.
IRS Publication 969:
Excess contributions.
You will have excess contributions if the contributions to your HSA for the year are greater than the limits discussed earlier. Excess contributions aren’t deductible. Excess contributions made by your employer are included in your gross income. If the excess contribution isn’t included in box 1 of Form W-2, you must report the excess as “Other income” on your tax return.
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.
You may withdraw some or all of the excess contributions and avoid paying the excise tax on the amount withdrawn if you meet the following conditions.
IRS Form 8889 Instructions:
Excess Contributions You Make
To figure your excess contributions (including those made on your behalf), subtract your deductible contributions (line 13) from your actual contributions (line 2). However, you can withdraw some or all of your excess contributions for 2020 and they will be treated as if they had not been contributed if:
Excess Employer Contributions
Excess employer contributions are the excess, if any, of your employer’s contributions over your limitation on line 8. If you made a qualified HSA funding distribution (line 10) during the tax year, reduce your limitation (line 8) by that distribution before you determine whether you have excess employer contributions. If the excess was not included in income on Form W-2, you must report it as “Other income” on your tax return. However, you can withdraw some or all of the excess employer contributions for 2020 and they will be treated as if they had not been contributed if:
Note. If you timely filed your return without withdrawing the excess contributions, you can still make the withdrawal no later than 6 months after the due date of your tax return, excluding extensions. If you do, file an amended return with “Filed pursuant to section 301.9100-2” written at the top. Include an explanation of the withdrawal. Make all necessary changes on the amended return (for example, if you reported the contributions as excess contributions on your original return, include an amended Form 5329 reflecting that the withdrawn contributions are no longer treated as having been contributed).
Include on line 14b any distributions you received in 2020 that qualified as a rollover contribution to another HSA. See Rollovers, earlier. Also include any excess contributions (and the earnings on those excess contributions) included on line 14a that were withdrawn by the due date, including extensions, of your return. See the instructions for line 13, earlier.