When Are Excess HSA Contributions Taxable? Avoid this Mistake + FAQs

Under federal law, any contribution to your HSA above the annual limit is considered an “excess contribution” and becomes taxable.

💡 Over 37 million Americans hold Health Savings Accounts (HSAs) with more than $120 billion in assets. Yet even with their popularity, excess HSA contributions are taxable in specific circumstances that can catch you off guard.

If you put more into your HSA than the annual IRS limit (for example, above $4,150 for self-only coverage in 2024 or $4,300 in 2025), that extra amount loses its tax-free status.

It will be treated as taxable income and hit with a 6% excise tax every year until you fix the mistake. In this comprehensive guide, we’ll unpack exactly when excess HSA contributions are taxable and how to handle them.

What you’ll learn:

• Exactly when and why the IRS taxes excess HSA contributions (and how the 6% penalty works under federal law)

• The pros and cons of dealing with an HSA over-contribution – including a quick-reference table of benefits vs. drawbacks

• How state tax laws vary for HSA contributions (🚩 spoiler: CA and NJ play by different rules – see all 50 states in our table)

• The top 3 scenarios that lead to HSA overfunding (from job changes to Medicare enrollment) and how to fix each without paying unnecessary penalties

• Practical tips and FAQs: key terms explained (excess contribution, excise tax, timely withdrawal, etc.), common mistakes to avoid, real IRS rulings and court cases on HSA excesses, real-life examples, plus comparisons of HSA rules vs. FSA and IRA rules for context

🎯 When Do Excess HSA Contributions Become Taxable? (Federal Rules Explained)

The IRS sets yearly HSA contribution limits based on your coverage type (self-only vs. family) and inflation adjustments. If you contribute more than allowed – whether by a dollar or a few thousand – two things happen:

• No tax benefit on the excess: You cannot deduct the excess portion (and if the excess came via pre-tax payroll, that amount must be added back as taxable income). Essentially, the extra contribution is treated as if it were never HSA-eligible, so it doesn’t get the normal tax break.

• 6% excise tax penalty: The IRS imposes a 6% excise tax on the excess amount. This is an additional tax – on top of regular income tax – specifically to penalize over-contributing. Importantly, this 6% tax applies each year on any excess still in your HSA.

In plain terms, excess HSA contributions are taxable because the IRS strips away their tax-advantaged status. The taxable moment occurs as soon as you exceed the limit for the year.

For example, if the 2025 limit is $4,300 for individual coverage and you contribute $4,800, that extra $500 is immediately an excess. You won’t get a deduction for that $500, and if not corrected, you’ll owe a $30 excise tax (6%) on it when you file taxes.

When exactly is the tax paid? The excise tax is reported on your tax return for the year of the over-contribution (using IRS Form 5329, which handles additional taxes on retirement accounts and HSAs). If the excess remains in the account into subsequent years, you’ll continue to owe 6% each year until it’s removed or absorbed by future contribution limits. In other words, the IRS will keep taxing that excess annually – it doesn’t just hit you once.

Key point: You can avoid the 6% recurring penalty by taking action before the deadline (more on that below). But if you do nothing, the excess contribution stays taxable every year. The IRS effectively treats it as never having been a valid HSA contribution at all.

Let’s break down a quick scenario under federal rules to illustrate when excess contributions become taxable:

• Imagine Jane’s HSA limit for the year is $3,850, but she accidentally contributes $4,350. The $500 extra is an excess contribution.

  • Jane cannot exclude or deduct that $500 on her taxes – it’s taxable income to her (since it’s beyond what’s allowed).

  • Additionally, because it’s excess, Jane will incur a 6% excise tax of $30 on that $500 when she files her taxes.

  • If Jane doesn’t correct it, next year another 6% ($30) will apply again, and so on each year.

In summary: Excess HSA contributions are taxable immediately in the sense that you get no tax break for them, and they trigger an excise tax each year until fixed. The IRS set it up this way to strongly discourage exceeding the HSA limits.

However, there’s relief if you act timely. Under IRS rules (26 U.S. Code § 223 and § 4973), an excess contribution won’t be penalized with the 6% tax if you withdraw it by the tax filing deadline (generally April 15 of the following year, which can extend to October 15 if you file an extension). We’ll cover that process in a moment, but the key is: excess contributions are taxable unless you proactively remove them within the allowed window.

Pros and Cons of Over-Contributing to an HSA

Nobody sets out to over-contribute to their HSA, but mistakes happen. Surprisingly, there are a few silver linings to an excess contribution along with the many downsides. Here’s a quick look at the benefits vs. drawbacks when you’ve put in too much to your HSA:

As you can see, the cons outweigh the pros for excess contributions. There’s no outright “benefit” to over-contributing on purpose – the tax advantages of an HSA stop at the annual limit. The only slight upsides are that the money is still yours (you won’t lose it, you just might pay some tax on it) and you can eventually re-route that excess into a future year’s contribution limit. Meanwhile, the downsides include real financial costs (extra taxes) and added complexity in your tax filings.

In short: while an excess contribution might earn a bit of interest in the short term or be usable for future HSA space, it creates headaches and penalties that usually outweigh any benefit. It’s best to avoid it or fix it quickly if it happens.

🗺️ State-by-State HSA Tax Treatment: Does Your State Tax Excess HSA Funds?

When it comes to state taxes, HSA contributions are usually given the same favorable treatment as federal – but not always. Most states conform to federal tax law, meaning HSA contributions are not taxed at the state level (and withdrawals for medical expenses aren’t taxed either). However, a couple of states do not follow the federal HSA rules, which affects all HSA contributions in those states, including any excess amounts.

Importantly, even in states that tax HSAs, the 6% excise tax is a federal tax only – states don’t impose a separate excise penalty for excess contributions. But states can tax the contributions and earnings themselves as regular income. Here’s a comprehensive 50-state breakdown of how HSA contributions (including excess contributions) are treated for state income tax purposes:

Looking at the table, the vast majority of states provide the same tax benefits as the federal government. Only California and New Jersey tax HSA contributions and earnings outright. If you live in one of those states, any contribution you make (even within federal limits) is added back to your state taxable income. Thus, an excess HSA contribution in California or New Jersey doesn’t change your state tax situation much – all your HSA contributions were taxed by the state anyway. You’d still want to remove the excess to avoid the federal 6% penalty, but there’s no extra state penalty beyond having already paid state income tax on it.

For states with no income tax (like Texas, Florida, etc.), there’s obviously no state HSA tax to worry about. And for special cases like New Hampshire, only investment earnings might be subject to a state tax (and even that is temporary as NH is phasing out its tax on interest/dividends).

Bottom line: Federally, HSAs have strict contribution limits with penalties for excess, but at the state level, only a couple of states will tax your HSA contributions themselves. Always consider your state’s stance – especially if you reside in CA or NJ – because it affects the overall tax impact of your HSA. However, the federal excise tax for excess contributions applies nationwide, no matter where you live.

💡 Oops! 3 Common Scenarios That Cause HSA Over-Contributions (and How to Handle Each)

What situations tend to lead people to accidentally contribute too much to their HSA? Knowing these in advance can help you avoid an “oops” moment. Here are the three most common scenarios, with a breakdown of how they happen, what the tax consequences are, and how to fix things if it happens to you:

These scenarios cover the big mistakes: multiple sources of funding, changes in eligibility, and miscommunication in family contributions. Let’s highlight a few nuances from them:

• Changing jobs or multiple HSAs: Because HSAs are individual accounts, it’s easy to accidentally over-contribute if you don’t coordinate. For instance, if you had an HSA at your first job and then your new job also contributes to a new HSA for you, the sum might exceed the annual limit. The IRS treats all your HSAs combined as one pot for the limit. Always keep tabs on the total. If you have two accounts, you might consider consolidating or at least tracking contributions in one place.

• Mid-year loss of eligibility: The HSA contribution limit is essentially prorated by the number of months you are an “eligible individual” (i.e., covered by a High-Deductible Health Plan and no disqualifying coverage). For example, if you only had HSA-qualified coverage for 6 months of the year, you’re normally limited to half of the annual contribution. Many people trip up via the last-month rule: this rule lets you contribute the full year’s amount if you’re HSA-eligible on December 1, regardless of earlier months. But it comes with a huge string attached: you must remain HSA-eligible through the entire next calendar year (the “testing period”), or the extra portion you contributed under this rule becomes taxable and a 10% penalty is added. This isn’t the standard 6% excess tax – it’s a separate penalty for breaking the eligibility requirement. Essentially, it turns that extra contribution into income (taxable) and slaps on a 10% fine. Example: You start an HDHP in July and use the last-month rule to contribute a full year’s HSA limit. If you then drop the HDHP in, say, March of the next year, the IRS will retroactively tax the extra half-year of contributions you made and add 10%. It’s a nasty surprise, so be cautious with that rule.

• Family plan over-contributions: When a married couple both have HSAs (which can happen if both spouses have their own HSA accounts, typically when either has self-only coverage or they just each opened one while on family coverage), the family contribution limit is a combined cap. For 2024, for example, the family limit is $8,300 – that’s not $8,300 each, but $8,300 total between the two. Couples must decide how to split that (it could be 50/50 or any split, even 0/100) but if the sum goes over, they have an excess. A common error is each spouse contributes the full family amount, effectively doubling the allowed total. Communication and planning prevent this. Likewise, for catch-up contributions after age 55: each spouse eligible for the $1,000 catch-up must contribute it to their own HSA. One spouse cannot deposit $2,000 of catch-ups in one account – that would leave $1,000 as excess because the other spouse’s catch-up doesn’t “count” in the first spouse’s HSA.

Knowing these scenarios, you can hopefully sidestep them. But if you find yourself in one of these situations and realize you over-contributed, don’t panic. There are remedies (as noted in the “Solution” column above): typically, either withdraw the excess (and any earnings on it) by the deadline or carry it forward by adjusting next year’s contributions downward. We’ll discuss those fixes in detail in the next sections.

🔑 Key Terms Demystified (Excess Contributions, Excise Tax, and More)

Before diving deeper into fixes and examples, let’s clarify some key terms related to HSA over-contributions and taxes. Understanding these will make it easier to navigate the rules and communicate with your HSA provider or tax preparer.

Excess Contribution

An excess HSA contribution is any amount contributed to your Health Savings Account above your allowed maximum for the year. This includes amounts over the annual dollar limit (set by IRS for self/family coverage) and amounts contributed when you weren’t eligible (for example, after you got Medicare or if you didn’t have an HDHP for part of the year and overfunded). Excess contributions do not qualify for tax-free treatment – you can’t deduct them, and they will be subject to a penalty tax until corrected.

6% Excise Tax

The 6% excise tax is the penalty tax the IRS charges on excess contributions to HSAs (and similarly to IRAs). It’s 6% of the excess amount and is assessed for each year the excess remains in the account. This tax is laid out in Section 4973 of the Internal Revenue Code. Notably, it’s considered an excise tax (essentially a special penalty tax), and the IRS treats it as a tax liability you report on your return (it’s not something the HSA bank withholds or anything; you must calculate and report it on Form 5329). If you remove the excess properly by the deadline, this 6% tax is not imposed at all. But if you miss the deadline, you’ll pay 6% and potentially keep paying 6% each year if the excess lingers. The excise tax is capped in a way – it will never exceed 6% of your HSA’s value, but in practice that’s not usually limiting unless your HSA lost a lot of value. The main thing to remember: 6% annually on the excess until fixed.

Timely Withdrawal (Correction by Deadline)

A timely withdrawal of an excess contribution means taking out the extra amount before the tax filing deadline for that tax year. For most people, that deadline is April 15 of the following year (it can be later if you file an extension, which pushes it to October 15). If you withdraw the excess contribution plus any income earned on that excess while it was in the HSA by that date, the IRS considers the issue corrected. In this case:

• The withdrawn excess contribution is not subject to the 6% excise tax.

• The earnings you withdraw will be counted as income (since those earnings accrued tax-free improperly), so you’ll include that small amount of interest/dividends in your taxable income.

• Crucially, the 20% penalty for non-medical withdrawals does NOT apply to this corrective distribution, even if you’re under 65. The IRS makes an exception so you’re not double-punished; as long as you’re withdrawing the money to fix an excess (and not spending it on non-medical stuff intentionally), you only pay regular tax on the earnings, no 20% penalty.

“Timely” in this context means on or before the filing due date, including extensions. If you file for an extension on your taxes, you effectively extend the window to fix your HSA contribution as well. Always notify your HSA custodian (the bank or institution managing your account) that you are taking a withdrawal of excess contributions. They will usually have a form or procedure to calculate any earnings attributable to that excess and process the distribution correctly.

Carryforward (Excess Applied to Next Year)

What if you missed the deadline to remove an excess, or you intentionally decide to leave it in the HSA? In that case, the IRS allows you to carry forward the excess by simply reducing your contribution in a subsequent year by that excess amount. For example, if you had a $500 excess in 2024 that you didn’t withdraw in time, you’ll pay the 6% tax for 2024. But in 2025, you can contribute $500 less than your normal limit, effectively “using up” that excess as part of your 2025 limit. Once you’ve offset it like this, it’s no longer considered excess going forward. However, note:

• You still paid 6% for the year it was excess (in our example, 2024). And if you don’t use it up in 2025, you’d pay 6% for 2025 as well, and so on.

• While the excess sits in the account, any earnings it generates are tax-free at the moment, but those earnings themselves become part of the HSA (and if you later remove them not for medical, they’d be taxable – but if you eventually spend them on medical after it’s all corrected, then they can be used tax-free like normal HSA funds).

• Carryforward is essentially the backup plan. It’s generally better to withdraw the excess, but if that ship has sailed, applying it to next year avoids perpetually paying 6%.

Eligible Individual

An “eligible individual” for HSA contributions is someone who meets the criteria to contribute to an HSA for a given month. Key points:

• You must be covered by a High Deductible Health Plan (HDHP) on the first day of that month.

• You have no other disqualifying coverage (for example, no traditional health plan, no Medicare, no full-purpose FSA through your employer or spouse’s employer, etc.).

• You can’t be claimed as a dependent on someone else’s tax return. If you meet these, you’re eligible to contribute (or have contributions made on your behalf) for that month, up to the prorated portion of the annual limit. Why does this matter for excess contributions? Because if at any point you weren’t an eligible individual but still contributed as if you were, those contributions are effectively excess (not allowed). A common instance is someone who unknowingly stays on an employer’s general-purpose FSA or gets covered by a spouse’s health plan that’s not HDHP – that disqualifies HSA contributions for that period, turning any made contributions into excess.

Form 5329

IRS Form 5329 is the form used to report and calculate additional taxes on tax-advantaged accounts, including the 6% excise tax on excess HSA contributions. If you have an excess that isn’t corrected by the deadline, you’ll need to file Form 5329 with your tax return to report the amount of excess and compute the 6% tax. On the form, you’ll carry over any prior-year excess that wasn’t fixed, report new excess, and so on. It’s also the form you use to report the 10% penalty if you fell afoul of the last-month rule (that penalty for not staying eligible the next year). In short, if you over-contribute and don’t fully fix it by withdrawal, expect to attach Form 5329 to let the IRS know you’re paying the required excise taxes.

HSA Custodian/Trustee

Your HSA custodian (or trustee) is the bank, credit union, brokerage, or financial institution that holds your HSA account. They are the ones who actually accept contributions, invest the funds (if applicable), and issue distributions. When it comes to excess contributions, the custodian plays a critical role in corrections:

• You must contact the custodian to request a withdrawal of excess contributions. They will often have a special form or process to calculate the net income attributable (the earnings on the excess) and process the removal properly.

• The custodian will issue tax forms related to the excess removal. Typically, a Form 1099-SA is issued for any distribution. If you removed an excess, it will be coded appropriately (often code “2” for a return of excess in the same year or before the due date). This lets the IRS know it was a corrective distribution.

• Custodians usually do not automatically prevent you from contributing over the limit (especially if you have multiple sources). They might notify you if one of your contributions exceeds the known limit, but they can’t know about other HSAs or other employer contributions. So it’s on you to monitor.

• If an employer contributed too much via payroll (like a mistake where they thought you were eligible or they accidentally double-paid), the custodian can sometimes return funds to the employer if notified within the year. But after year-end, it usually falls to you and the employer to sort out via W-2 corrections and your own withdrawal.

Understanding these terms and roles sets the stage for taking action. Now, let’s move from definitions to actions and mistakes to avoid.

❌ What Not to Do: Avoid These HSA Over-Contribution Pitfalls

Managing an HSA can be straightforward, but there are a few common pitfalls that lead people into trouble with excess contributions. Here are some mistakes to avoid so you don’t end up inadvertently giving the IRS extra money:

• Don’t “set and forget” your contribution amount if your status changes. If you start the year planning to max out your HSA, that’s great – but if you switch health plans mid-year or get Medicare, stop contributions immediately. A lot of excess contributions happen because someone changed jobs or insurance and forgot to adjust their HSA contributions accordingly.

• Never assume your employer or HSA provider will cap things for you. Employers will stop at the limit for their contributions, but they might not know about other contributions you make. And your HSA custodian usually won’t reject deposits until you’re way over (and they might not know about other accounts). Always track your contributions yourself. If you have multiple employers in one year, remember all of them combined count toward the one IRS limit.

• Avoid contributing the full annual limit twice when you have family coverage. This one hits married couples often. If you and your spouse each have an HSA, coordinate how much each will contribute so that together you hit the family max, not double it. Miscommunication here is a top cause of excess contributions.

• Be cautious with the last-month rule. As explained earlier, contributing the full year’s amount when you weren’t covered all year can backfire if you can’t stay HSA-eligible the next year. If there’s any doubt about maintaining HDHP coverage for the following year, it’s safer to contribute only the prorated amount for the months you had the HDHP. Otherwise, you might face a surprise tax (and 10% penalty) later. In short, don’t overuse the last-month rule unless you’re sure you’ll meet the testing period requirement.

• Don’t miss the excess removal deadline. If you do accidentally over-contribute, mark your calendar for the tax filing deadline to get it corrected. Waiting too long means you lock in the 6% penalty for that year, and possibly complicate things. It’s a simple fix if done in time. Procrastinating is costly here.

• Double-check before you contribute catch-up amounts. Only those age 55 or older can contribute an extra $1,000. If you’re under 55 (or if your spouse tries to put a catch-up in your account when it should go in their own), that extra $1,000 is not allowed. Sometimes people get confused on whose account the catch-up goes into – ensure the extra contribution is made to the account of the person who is 55+.

• Don’t ignore notices or forms from your HSA custodian. Some HSA providers send alerts if they detect an excess (for instance, if you contribute online and exceed the known IRS limit). Also, when you do withdraw an excess, they’ll send a 1099-SA and possibly a letter explaining how it’s reported. Read those and include the info on your tax return. A common mistake is to withdraw excess but then not report the earnings as income – leading the IRS to send a letter for underreporting income.

By steering clear of these mistakes, you greatly reduce the chances of ending up with an excess contribution issue. Being proactive and informed is your best defense: keep track of contributions (especially around life events or coverage changes), communicate with anyone else contributing on your behalf, and adjust as needed before it becomes an excess problem.

⚖️ IRS Rules and Court Rulings Shaping Excess HSA Contribution Treatment

The handling of excess HSA contributions isn’t just ad-hoc – it’s grounded in tax law and has been refined by IRS guidance (and even a few court and IRS rulings). Understanding the legal backdrop can give you insight into how rigid these rules are and why there’s little wiggle room for exceptions.

Internal Revenue Code & Regulations: The basis for HSA excess taxation comes from two main code sections:

• IRC §223 – establishes HSAs, contribution limits, eligibility, etc. (Originally enacted by the Medicare Modernization Act of 2003).

• IRC §4973 – a section that imposes excise taxes on excess contributions to various tax-favored accounts (IRAs, HSAs, etc.). Specifically, §4973(a)(5) makes excess HSA contributions subject to a 6% tax each year.

These laws make it clear that an excess contribution will incur a tax until corrected. Unlike some penalties that the IRS can waive for reasonable cause, the 6% excise is essentially automatic by law. In fact, tax practitioners often note that this 6% is treated as a tax rather than a penalty. That distinction matters because if it were a “penalty,” one might argue for abatement under certain relief provisions, but as a “tax,” if it applies, you owe it, period. In the context of IRAs, courts have emphasized that the 6% on excess contributions is a tax (for example, in cases dealing with huge excess IRA contributions, the Tax Court reinforced that the individual had to pay 6% until removed, no exceptions).

IRS guidance and letters: The IRS has issued specific guidance clarifying how to correct or handle mistaken HSA contributions:

• IRS Notice 2008-59 – This notice provided Q&A guidance on many HSA issues. Notably, it outlined limited situations where an employer can recoup contributions made in error. For instance, if an employer mistakenly contributes more than the legal limit or contributes for an ineligible individual, the notice generally said the employer cannot simply take the money back out of the HSA (once in an HSA, funds belong to the employee). The employer’s remedy is to correct wages (i.e., include it in taxable income) and the employee then has an excess to deal with. This set a baseline that mistaken contributions are usually treated as excess contributions on the employee’s side (unless fixed by the deadline).

• IRS Information Letter 2018-0033 – The IRS expanded on the 2008 guidance with some examples where an employer could retrieve funds (for example, if an employee was never eligible for an HSA at all or if an administrative error caused an over-contribution). But even then, those situations are specific and must be well-documented. The bottom line remains: it’s hard to “undo” an HSA contribution after the fact without treating it as excess.

Example rulings:

• The IRS has consistently held that if you contribute while not eligible (say, after enrolling in Medicare or while having a non-HDHP), those contributions are excess. In a published information letter in 2016, the IRS addressed retroactive Medicare coverage. Sometimes when you sign up for Medicare Part A late, Medicare can retroactively cover you for up to 6 months. That means you technically weren’t eligible to contribute to an HSA during those retroactive months, even though you didn’t have Medicare at the time. The IRS letter affirmed that there’s no exception for this scenario – if you unknowingly over-contributed because of retroactive Medicare, you still have an excess. The relief is the same: withdraw by the deadline to avoid the 6%. (They noted you wouldn’t face the 20% penalty on that withdrawal and, if you’re over 65 by then, you could withdraw without 20% penalty anyway, but you’d still include it in income if not timely corrected.)

• In tax literature and commentary, cases involving gigantic contribution errors (mostly with IRAs, not many people have huge HSA excesses due to the lower limits) have been cited to illustrate that the 6% excise applies strictly. For example, one Tax Court case involved an attempted $25 million IRA contribution (far exceeding limits via a complex scheme). The court ruled almost the entire amount was an excess contribution, subject to excise taxes. While that’s an IRA, the principle carries to HSAs: the IRS and courts do not show leniency for ignoring contribution limits, regardless of dollar amount.

No statute of limitations on excess until fixed: It’s worth noting that because the excess contribution excise is a yearly tax, the clock doesn’t run out on it in the usual way. If you made an excess contribution and somehow never reported it, the IRS could come knocking years later, because technically each year’s 6% is a new tax liability. There have been situations with IRAs where someone didn’t realize for a long time – they had to pay back taxes and interest for each year’s 6%. So compliance is important.

In summary, the IRS stance is rigid: HSA contributions above the limit are not allowed to retain tax benefits, and the only remedies are those explicitly provided (timely withdrawal or future offset). The guidance and rulings over the years have primarily clarified procedural aspects (like employer mistakes, Medicare issues) but haven’t opened any loopholes to escape the 6% excise if an excess isn’t corrected in time. Court cases dealing with related topics consistently underscore that taxpayers are responsible for adhering to contribution limits. So, from a legal perspective, it’s cut and dry: excess = 6% tax every year, unless fixed.

📚 Real-Life Examples: How Excess Contributions Impact Taxpayers

Sometimes it helps to see how these rules play out for actual people. Let’s walk through a few realistic scenarios where taxpayers encountered excess HSA contributions, and see what happened:

• Example 1: The Job Hopper Overshoot – Alex had an HSA with his first employer and maxed out his personal contributions early in the year, putting in $3,850 (the full limit for self-only coverage in 2023). In July, he changed jobs to a company that also offered an HSA. Without realizing, he kept the default payroll contribution at the new job, which added another $1,000 by year-end. Alex ended up contributing $4,850 total, exceeding the $3,850 limit by $1,000. Come tax time, he caught the mistake. Here’s how it unfolded: He contacted the HSA custodian and withdrew the $1,000 excess in February 2024, before filing his taxes. The $1,000 had earned about $20 in interest while sitting in the HSA. The custodian calculated that and gave him a total withdrawal of $1,020. Alex had to include the $20 interest as income on his 2023 tax return (since that $20 was not for qualified medical use). But by removing the excess, Alex avoided the 6% excise tax altogether. He also made sure to only deduct $3,850 (the allowed amount) on his tax return. Outcome: Alex paid regular income tax on $20 he withdrew, and no penalties. Had he not caught it, he would have owed $60 (6% of $1,000) for 2023 and had to pay 6% each year until fixed. This example shows that even a mid-year job switch can cause an excess, but swift correction saved the day.

• Example 2: The Late Discovery – Brenda and Carl are a married couple with family HDHP coverage. In 2021, both of them, not communicating well, contributed the full family limit into their separate HSAs. The limit was $7,200, so they inadvertently put in $14,400 (an excess of $7,200). They didn’t realize the error for a while. In fact, they didn’t catch it during filing 2021 taxes. By late 2022, Brenda was reviewing finances and the lightbulb went off. By that time, the excess $7,200 had remained in the accounts all through 2021 and 2022, earning some investment gains. When they figured it out, it was too late to withdraw for 2021 without incurring penalties, but they acted to fix going forward:

  • For 2021, they ended up each owing a 6% excise tax on their respective excess portions (total $432 in penalties, since $7,200 * 6% = $432). They filed Form 5329 with their 2021 returns (actually they had to amend once they discovered, to report it).

  • They did not withdraw the excess in 2022 either, but they decided to apply it to 2023. This meant in 2023 they contributed $7,200 less than the normal family limit (essentially, they contributed $0 in 2023 because they treated that excess as their contribution – they just left it in the account). They still had to pay another $432 (6%) for the year 2022 on that excess because it wasn’t gone until the end of 2022.

  • By 2023, after reducing contributions, the excess was absorbed (now their HSA balances only contained allowed contributions). No further 6% applied for 2023 or beyond.

  • They did, however, have to pay income tax on the earnings that the excess generated when they eventually withdraw those earnings (if not used for medical). In their case, they left the earnings in the HSA and will likely just use that money for medical expenses eventually (which effectively sanitizes it – once the contribution is no longer “excess”, any earnings become just normal HSA funds, usable tax-free for medical).

  This example shows how an oversight can snowball. Brenda and Carl paid $864 in excise taxes over two years – essentially a costly lesson. The silver lining was that by not contributing new money for a while, they eventually cured the excess. But imagine if they hadn’t noticed for 5 years – the penalties would keep stacking each year.

• Example 3: The Medicare Mix-Up – Diane turned 65 in June 2024 and enrolled in Medicare Part A right away. She had been contributing to an HSA monthly earlier in 2024, unaware that Medicare enrollment would affect this. By June, she had contributed $2,075 (half of the $4,150 individual limit). Once on Medicare, she’s no longer allowed to contribute. But Diane’s automatic contributions continued for a couple months until she realized in September. She ended up contributing an extra $700 after June while she was on Medicare – making that $700 an excess contribution (since from July onward, her contribution limit was actually $0 due to Medicare). Diane acted quickly when she realized: she contacted the HSA bank and requested a withdrawal of the $700 excess plus earnings. Because this was done before the tax deadline, she avoided the 6% penalty. She did have to include about $10 of earnings in her income. However, had she not caught it and withdrawn, that $700 would incur a $42 excise tax yearly. Additionally, because she wasn’t eligible at all for those months, she couldn’t carry it forward (since as long as she has Medicare, she can’t contribute in future years either). In her case, withdrawal was the only true fix. This illustrates an important point: retirement and Medicare can create excess contributions if you don’t stop HSA funding on time. Always stop HSA contributions before the month you start Medicare to avoid this scenario.

Each of these examples highlights different causes and remedies:

• The timely fix (Alex) is relatively painless.

• The delayed fix (Brenda & Carl) shows the accumulating penalty and the carryforward method.

• The ineligibility fix (Diane) emphasizes acting fast once you realize.

Real taxpayers often share these stories on forums like Reddit or ask about them when they get IRS notices. The common theme is that once an excess is discovered, the best course is to correct it as soon as possible, either by withdrawing or by adjusting future contributions. The longer an excess sits uncorrected, the more years of 6% penalties you rack up.

🔄 HSA vs. FSA vs. IRA: How Do Contribution Rules and Penalties Compare?

HSAs aren’t the only tax-advantaged accounts with contribution limits. If you’re familiar with Flexible Spending Accounts (FSAs) or Individual Retirement Accounts (IRAs), you might wonder how HSA rules stack up. Here’s a comparison of contribution rules and tax treatments for HSAs, FSAs, and IRAs, particularly focusing on what happens if you contribute too much:

Key takeaways from the comparison:

• All three accounts have annual contribution limits, but they differ in amount and eligibility. HSAs require HDHP coverage, FSAs require an employer that offers it (and you generally can’t have an HSA and a general health FSA at the same time), IRAs require you to have earned income (and there are additional conditions for deductibility or Roth contributions). The dollar limits also vary: HSA family limits are somewhat high (in the $8k range), whereas FSA is around $3k and IRA is around $6.5k.

• Tax treatment: HSAs and traditional IRAs share the trait that contributions can be pre-tax or deductible, giving immediate tax savings. FSAs are also pre-tax through payroll. Roth IRAs don’t give an upfront deduction but offer tax-free withdrawals later. HSAs uniquely offer the trifecta of tax-free in, growth, and out (if used for medical). That means an HSA is powerful, but the flip side is the IRS is strict about not letting you put extra in beyond the limit.

• Excess contributions penalties: HSAs and IRAs are very similar here – both hit you with a 6% excise tax annually until you correct the excess. The mechanism to fix it (withdraw excess by the deadline or carry it forward) is basically the same. In contrast, FSAs don’t have an excise tax because you typically can’t contribute above the legal limit in the first place (your employer’s plan will limit your election). The “penalty” with an FSA is different: if you don’t use the funds for eligible expenses in time, you lose them. But you won’t get a tax penalty for putting in too much, since that scenario is prevented upfront.

• Carryover and flexibility: HSAs and IRAs allow you to carry balances year to year indefinitely. If you accidentally put too much in, you have time to fix it or reallocate it to next year (with that 6% cost per year until fixed). FSAs are yearly use-it-or-lose-it arrangements (with limited rollover), so there’s no concept of carrying forward an excess – you either spend it or lose it, and contribution limits reset each plan year.

• Withdrawal penalties: Not directly about contributions, but notable: HSAs have a 20% penalty on withdrawals if used for non-medical purposes under age 65. IRAs have a 10% penalty on early withdrawals (under 59½) unless an exception applies. FSAs simply disallow non-medical use entirely (you can’t take FSA money as cash – it must reimburse expenses, or it’s gone). We mention this because sometimes people confuse the withdrawal penalties with the contribution penalties. With an HSA excess, when you withdraw that excess it’s exempt from the usual 20% penalty (because it’s corrective). IRAs similarly don’t charge the 10% early withdrawal penalty if you’re removing an excess contribution (provided you do it properly). So the IRS gives a path to fix contributions without layering on withdrawal penalties, which is good.

In essence, HSAs and IRAs require similar vigilance: don’t overfund, and if you do, take action within the allowed time. FSAs are more of a “use what you elected” system and you typically can’t go over since it’s controlled through your employer’s plan.

For those who have all three types (say, an HSA for health, plus maybe an IRA for retirement, and an FSA for dependent care or something), it’s helpful to keep the rules separate. Each has its own purpose and limits, but overfunding an HSA or IRA carries a sting that FSA users don’t experience in the same way.

🤝 Who’s Involved? IRS, HSA Custodians, State Tax Agencies, and More

When dealing with HSA contributions and potential excesses, several players come into the picture. It’s useful to know who does what and how they connect:

• Internal Revenue Service (IRS): The IRS is the ultimate authority on HSA tax rules. They set annual contribution limits (announced each year, usually mid-year for the next year’s limits). The IRS also enforces the rules through tax forms:

  • They require you to file Form 8889 with your tax return to report HSA contributions and distributions. This is where you’d normally claim your deduction or report employer contributions (which were excluded from wages).

  • They require Form 5329 if you have an excise tax to report (as discussed).

  • The IRS collects the 6% excise tax if applicable, and any income taxes due on excess contributions or earnings.

  • Essentially, the IRS makes the rules and collects the revenue from any mistakes. If you have an issue (like needing to amend a return or resolve a penalty), you or your tax advisor will be dealing with the IRS.

• HSA Custodians/Trustees: These are banks or financial institutions that hold HSA accounts. Examples include Optum Bank, HealthEquity, Fidelity, local credit unions, etc. They are required to report contributions and distributions to both you and the IRS:

  • Each year you’ll get a Form 5498-SA from the custodian (usually in May, annoyingly after tax filing) which reports total contributions received for the prior year. This is how the IRS knows how much went into your HSA.

  • If you take distributions, the custodian issues Form 1099-SA showing how much was taken out and for what reason (normal, excess removal, death, etc., indicated by codes).

  • Custodians facilitate excess corrections. If you request an excess withdrawal, they will calculate the earnings and generate the appropriate paperwork. They often have help lines or FAQs on this since it’s a common issue.

  • Note: Custodians are not responsible for enforcing the IRS limit across multiple employers or accounts. They only see what goes into the account with them. They might stop you if with them you try to contribute above the yearly max, but many people have more than one HSA in a year (when switching jobs or using an IRA-to-HSA rollover, etc.). So you can’t rely on the bank to say “hey, you already put in too much.” You might get a courtesy warning in some cases, but oversight is on you.

• State Tax Agencies (e.g., State Departments of Revenue): These are the state-level “IRS” equivalents. For most states that conform, you won’t have much interaction specific to HSA beyond maybe adding back the amount on a state tax form. But in states like California or New Jersey, the state tax agency:

  • Taxes your HSA contributions as part of your state income. This means your W-2 from your employer will have a higher state wage figure than federal if you did HSA payroll contributions (because those contributions are added back for state).

  • Expects you to include any HSA interest or investment earnings as state taxable income (even though federally it’s tax-free). For example, CA has a form (FTB 3805P for certain penalties, but generally, you just include HSA earnings as “other income” on Schedule CA). New Jersey similarly requires including HSA earnings.

  • If you have an excess contribution, from the state’s perspective, they were taxing all contributions anyway (in CA/NJ). So there’s no additional state penalty. However, if you paid the 6% excise to the IRS, that excise tax is not deductible on your federal or state return (excise taxes are considered a personal penalty, not a business or property tax), so you eat that cost. State agencies don’t really need to do anything special for HSA excess, except they benefit from taxing the HSA money that the feds wouldn’t normally tax.

  • It’s good to be aware that if you live in a non-conforming state, you may have to file a couple of extra lines on your state return related to your HSA. And if you remove an excess, the earnings you include in federal income will automatically be in state income too (since state starts from federal usually).

• Employers and Payroll Providers: Employers play a role if they facilitate HSA contributions through payroll (which is very common). They:

  • Exclude HSA contributions from your W-2 Box 1 (federal wages) if done through a cafeteria plan. However, in CA/NJ, those amounts are included in state wages on the W-2.

  • If they contribute company money (employer contributions), they also report that in Box 12 of your W-2 with code W (which along with your own payroll contributions makes up the total shown, which should match what you put on Form 8889).

  • If an employer discovers they contributed too much for you (maybe they thought you were family coverage but you switched to single, etc.), they might try to get the money back from the HSA custodian or adjust your pay. As IRS guidance states, their ability to pull money back is very limited. Most of the time, the correction involves issuing a corrected W-2 (adding the excess back into taxable wages) and then you as the account holder taking out the excess from the HSA. So the employer’s actions and your actions have to coordinate.

  • Bottom line: Employers can help prevent excess by stopping contributions when you tell them you’ve hit a limit elsewhere, but they only know what you tell them (and what’s in their control). They aren’t automatically notified about your contributions made outside payroll.

• Tax Preparers/Advisors: If you use a CPA or tax software, these entities help navigate the forms. It’s worth noting that many people get tripped up by tax software questions around HSAs. For example, TurboTax might flag an excess based on the 5498-SA info and ask if you withdrew it, etc. A preparer can ensure Form 5329 is properly filed and any excess is handled in the return.

All these parties are connected in that they exchange information to ensure compliance. For instance:

• Your HSA custodian reports contributions to both you and the IRS.

• Your employer reports payroll contributions on your W-2 (to you, IRS, state).

• You report on your tax return and reconcile any differences, and the IRS matches what you report with what the custodian reported.

• If something doesn’t match (say you contribute over the limit and don’t report an excess), the IRS might send a notice CP2000 proposing more tax, using the data from the 5498-SA that the bank gave them.

• The state tax agency might pull info from your federal return (some states get federal data) and see HSA amounts, or they rely on you to add it back on the state form.

In summary, handling an HSA correctly is a bit of a team effort:

• You are the quarterback making sure contributions are correct and taking action if needed.

• The IRS provides the playbook (rules) and referees the game (enforces taxes).

• The custodian is like the keeper of records and the ball (money) – they execute transactions on your say-so and report data.

• The state agency might be an additional referee if they don’t follow the same rules as the IRS.

• Employers and their payroll systems are like coaches on the sideline – they can help you get it right, but they can also call a bad play if information isn’t clear (e.g., inadvertently over-fund your HSA match).

Knowing who does what can help you troubleshoot if something goes wrong. For example, if you realize you’re over, you call the custodian to initiate a removal. If you get an IRS letter, you or your tax advisor answer it, explaining any correction. If your employer over-contributed, you might need a corrected W-2 from them. Understanding these connections ensures you get the right help from the right place.

FAQ: Quick Answers to Common Questions

Do I have to pay the 6% HSA penalty each year until I fix the excess?
Yes. The 6% excise tax is charged every year the excess remains in your HSA. It stops only after you withdraw the extra funds or offset them by reducing a future year’s contribution.

Can I withdraw excess HSA contributions without paying a penalty?
Yes. If you remove the excess (and any earnings) by the tax filing deadline, you avoid the 6% excise tax. Only the earnings withdrawn will be taxable as income (no 20% penalty applies to the withdrawal).

Is there a deadline to remove an excess HSA contribution?
Yes. Withdraw the excess by the tax filing deadline (typically April 15 of the next year, or October 15 with an extension) to avoid the 6% penalty. After this “grace period,” the 6% tax for that year becomes due.

Can I carry over excess HSA contributions to next year?
Yes. You can apply an excess to the next year’s HSA limit by reducing next year’s contributions by that amount. You’ll still owe the 6% excise tax for the current year’s excess, but after using it up next year, the penalty stops.

Do employer contributions count toward my HSA limit?
Yes. All contributions from any source (you, your employer, family members, etc.) count toward the annual HSA cap. Employer contributions use up part of your limit just like the money you contribute yourself.

Are HSA contributions tax-deductible in California and New Jersey?
No. California and New Jersey do not recognize HSAs as tax-free accounts. HSA contributions are included in your taxable income for state purposes, and any HSA interest or investment earnings are also subject to state income tax.

I contributed to my HSA after enrolling in Medicare – will I be penalized?
Yes. Once you have Medicare, any HSA contributions are ineligible and treated as excess. They’ll incur the 6% excise tax for each year they remain in the account unless you withdraw them.

If I withdraw the excess HSA money, will I owe the 20% penalty for using it non-medically?
No. Corrective distributions of excess contributions are not subject to the 20% additional penalty (even if you’re under 65). You’ll just pay regular income tax on any earnings from the excess that you withdraw.

I already spent my excess HSA contribution on medical expenses – do I still need to fix it?
Yes. The contribution was still excess. If the money is gone, you obviously can’t withdraw it now, but that excess amount is still subject to the 6% tax each year. You should reduce future contributions by that excess to eliminate it going forward (and you’ll owe 6% for the year of the overage). The fact that it was spent on medical means you at least used it for a good purpose tax-free, but it doesn’t exempt the contribution from being classified as excess.