If your employer contributes more than the IRS-mandated limit to your Health Savings Account (HSA), these excess funds can lead to significant tax penalties for the HSA owner if not properly addressed.
Understanding HSA Contribution Limits
The Internal Revenue Service (IRS) sets annual limits on the total amount that can be contributed to an HSA. These limits apply to all contributions from all sources, including those made by your employer, you (through payroll deductions or direct contributions), and any third parties. Exceeding these limits, even due to employer contributions, makes the excess amount subject to specific penalties.
The Impact of Excess Employer Contributions
When employer contributions cause your HSA to exceed the annual limit, the amount over the limit is considered an "excess contribution." This carries important consequences for the individual HSA owner.
- Excise Tax Imposed: If excess individual and employer contributions made to your HSA are not removed within the same tax year they were made, the HSA owner will generally face a 6% excise tax for each tax year the excess remains in the account. This penalty is not a one-time fee; it is assessed annually on the excess amount until it is removed.
- Taxable Income: While regular HSA contributions are tax-deductible or made pre-tax, excess contributions are not. They may also be subject to income tax if not properly handled.
Identifying and Correcting Excess Contributions
The responsibility for ensuring HSA contributions stay within IRS limits ultimately lies with the individual HSA owner, even when the excess is due to employer contributions. Prompt action is crucial to avoid or minimize penalties.
Steps to Correct Excess Contributions:
- Determine the Excess Amount: Calculate the precise amount by which your total contributions (employer + individual) exceeded the annual IRS limit for that tax year. Remember to factor in any catch-up contributions if you are age 55 or older.
- Contact Your HSA Custodian: Inform your HSA administrator or custodian that you have an excess contribution and request a "return of excess contribution."
- Withdraw the Excess and Earnings: You must withdraw the excess contribution amount, along with any net income attributable to that excess contribution. The earnings on the excess are generally taxable in the year they are withdrawn.
- Report on Your Tax Return: You must report the excess contributions and any corrections on your tax return using IRS Form 8889, Health Savings Accounts (HSAs). This form is essential for proper reporting to the IRS.
- Timely Removal is Key: To avoid the recurring 6% excise tax, it's crucial to identify and withdraw any excess contributions, along with any earnings attributable to them, by the due date of your tax return for the year the excess occurred (typically April 15th of the following year, including extensions). Removing the excess by this deadline effectively treats it as though it was never contributed, thereby avoiding the excise tax for that year.
Example Scenario
Imagine the 2023 HSA contribution limit for an individual is $3,850.
- Your employer contributes $4,000 to your HSA in 2023.
- You contribute $0.
- Your total contribution is $4,000, meaning you have an excess of $150 ($4,000 - $3,850).
What happens next?
| Action/Scenario | Consequence/Outcome |
|---|---|
| Excess contribution made in 2023 | $150 over the limit. |
| Not removed within same tax year (by Dec 31, 2023) | A 6% excise tax ($9.00) is imposed on the HSA owner for the 2023 tax year. |
| Excess (plus earnings) removed by April 15, 2024 (or extended deadline) | The $150 excess is treated as if it was never contributed for tax purposes. You avoid the 6% excise tax for 2023. Any earnings on the $150 are taxable in 2024. |
| Excess remains in 2024 | Another 6% excise tax ($9.00) is imposed for the 2024 tax year, and so on, for each year it remains in the account. |
Employer's Role and Best Practices
While the individual is ultimately responsible, employers should also strive to avoid making excess contributions. Clear communication between employers and employees regarding HSA contributions, annual limits, and any potential for over-contribution can help prevent these issues. Employees should regularly monitor their HSA statements and be aware of the IRS contribution limits.
By understanding the rules and taking timely action, you can avoid penalties and keep your HSA compliant with IRS regulations.
