Overview

This article discusses several aspects of ineligible contributions to Health Savings Accounts (HSAs), including options available to an HSA owner to correct an excess contribution, a possible solution for correcting an excess contribution when there is an insufficient balance left in an HSA to correct the excess, and ineligible contributions made by an employer. First, we will review the 2014 and 2015 HSA regular contribution limits. 

HSA Contribution Limits

An ineligible contribution generally results in an excess contribution. The most common example is a regular contribution that exceeds the contribution limit. An excess regular contribution:

• Is not deductible
• Is subject to a 6 percent penalty tax unless corrected by the deadline – an HSA owner’s tax-filing due date, plus extensions (generally October 15 for timely filers) of the year after the year for which the contribution was made

Correcting an Excess Contribution

There are two ways for an HSA owner to correct an excess contribution – by removal or by applying it in a subsequent year.

Removal: To correct an excess HSA contribution and avoid a 6 percent penalty tax, an HSA owner must remove the excess amount from the account by the deadline. The net income attributable to the excess amount must accompany the distribution of the excess. Because a tax deduction is not allowed for an excess contribution, when removed it is not taxable. However, any net income attributable to an excess is subject to tax in the year of the distribution.

Report the removal of the excess contribution on an IRS Form 1099-SA, showing the total amount  removed (i.e., excess plus net income attributable) in box 1, net income attributable only in box 2, and distribution Code 2 in box 3. A separate Form 1099-SA is necessary to report other distribution types.

Applying in a subsequent year: An HSA owner could apply the entire excess amount to a subsequent year, assuming the regular contribution, including the applied amount, does not exceed the limit for that year. However, he/she would owe a 6 percent penalty tax for each year he/she fails to correct the excess.

Example 1:

John Wilson contributes $2,000 too much to his HSA for tax year 2014. In March of 2015, John removed the $2,000 plus $18 of interest the $2,000 earned while it was in the account. He does not take a deduction for the $2,000 excess amount and must include the $18 of interest as income on his 2015 income tax return. He will receive a 2015 Form 1099-SA from his HSA custodian in January of 2016. The 1099-SA will show $2,018 in box 1, $18 in box 2, and distribution Code 2 in box 3.

Example 2:

John Wilson contributes $2,000 too much to his HSA for tax year 2014; however, he does not remove the excess. Rather, he leaves it in his HSA and takes a deduction for it on his 2015 tax return as a 2015 HSA regular contribution. John owes a 6 percent penalty tax ($120) on the $2,000 excess for tax year 2014.

Insufficient HSA Balance to Correct an Excess

If an individual has already taken distributions prior to discovering that an excess contribution exists, an HSA may have an insufficient balance to remove the excess contribution and net income attributable.

A possible solution is to treat any remaining balance as an excess and remove it with net income attributable, and reclassify previously taken normal distributions as the return of an excess contribution plus net income attributable. As part of this solution, an HSA custodian may change pending reporting and/or correct reporting already completed, to reflect the returned excess contribution (Code 2) rather than a normal distribution (Code 1) for the returned excess contribution plus net income attributable. Another possible solution, if the HSA owner is still eligible, is to wait until the HSA owner makes a regular contribution for the subsequent year. Then there may be enough money in the HSA to process the correction by the deadline.

Ineligible Employer Contributions

Ineligible employer contributions result if an employer:

• Contributes on behalf of an employee who was never an eligible individual, or
• By itself contributes more than the annual limit

The result if an employer contributes on behalf of an employee who was never eligible is that there was never an HSA:

• An employer may request the return of non HSA amounts, plus earnings, and if so, it may be returned to the employer by December 31 of the contribution year
• Amounts not recovered by the end of the contribution year by the employer are reported as wages on the employee’s Form W-2, and result in assets in an account that is not an HSA on behalf of the employee/individual
• There is no HSA reporting for the contributions or related distributions (eliminate all HSA reporting for the account), rather the account is just the individual’s  regular investment/checking account, apparently subject to tax reporting rules for the type of account (e.g., Form 1099–INT)

The result if an employer contributes more than the annual limit to an employee’s HSA is an excess contribution:

• An employer may request the return of the ineligible contribution amount plus earnings, and if so, it may be returned to the employer by December 31 of the contribution year
• There is no reporting of the excess contribution or related distributions when the amount is returned to the employer by December 31 of the contribution year. In other words, for tax reporting purposes, treat the excess contribution as if it never happened
• Amounts not recovered by the end of the contribution year by the employer should be reported as wages on the employee’s Form W-2, and result in an excess contribution which should be corrected by the HSA owner

Note: If the excess was the result of a combination of employer and HSA owner contributions, and the employer contributions alone did not exceed the limit, the result is just a regular excess contribution to the HSA, and the employer cannot recoup any contribution amounts from the HSA.

Conclusion

Though each HSA owner is responsible for determining his/her contribution limit, Article I of the HSA agreement indicates that an HSA custodian has some responsibility in monitoring contribution amounts. Article I states “No contributions will be accepted by the custodian for any account owner that exceeds the maximum amount for family coverage plus the catch-up contribution”. For this reason, and in an attempt to prevent excess contributions in general, an HSA custodian should check with its data processor to see if its system can monitor maximum contribution limits. The ability to monitor HSA contributions as they occur, thereby preventing excess contributions, saves time and money for custodians and HSA owners. Familiarity with the rules described above for correcting excesses and dealing with ineligible employer contributions is essential to efficient HSA administration.

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