The client hired an employee that took HDHP family medical coverage effective 2/22/2021 with an HSA. The company contributes to the HSA and the employee may also have contributed to it. We just learned that the employee has been enrolled in Medicare Part A since March 2020, which raises multiple questions.
Assuming 2021 taxes have been filed and the employee included the HSA information, does the fact the employee has family coverage make a difference as to his options on how to remedy the tax filing?
Unfortunately, no. An individual enrolled in Medicare is ineligible to make or receive HSA contributions. It does not matter that the HDHP coverage was individual or family coverage.
If the employee is audited, would he have to pay taxes on the 2021 contributions and a 10% penalty?
HSA contributions made by (or on behalf of) an ineligible individual are considered excess contributions, and an excise tax of 6% is imposed on the HSA holder for all excess contributions. This tax is cumulative and charged each year against the excess contributions remaining in the account until corrected. The employee should contact the HSA trustee/custodian and request an “excess contribution correction.” He or she will report that amount as income on this year’s return and pay the excise tax on the 2021 contributions. If the 2022 contributions are removed this year, there will be no excise tax on the 2022 excess contributions.
Do extended deadlines come into play so that the employee could fix this error?
No, the extended deadlines for withdrawing excess HSA contributions only applied to 2019 and 2020 tax years.
Should the employer reverse all HSA contributions for 2022 (employee and employer contributions)?
HSA contributions are generally nonforfeitable. There is an exception if the employee was never eligible for employer HSA contributions, as in the situation you describe. The employer may request that the HSA trustee/custodian return current year employer contributions (plus earnings, less any losses and administration fees paid directly from the account). If the employer recovers its 2022 contributions before the end of the year, those contributions are disregarded as if they were never made. The employer may not recoup 2021 employer contributions this year. Instead, the employer must issue a corrected 2021 Form W-2, and presuming the employee already filed using the incorrect Form W-2, the employee would need to file an amended 2021 return.
Can the employer provide the company contributions as additional income only to employees enrolled in the HDHP but ineligible to contribute to an HSA?
Employer HSA contributions are not subject to income, FICA, or FUTA withholding if the employer reasonably believes the employee is HSA eligible. Here, the employer knows the employee is not HSA eligible, so the employer cannot contribute. If the employer instead characterizes its “contributions” as additional income, it will be responsible for withholding and paying its share of FICA and FUTA taxes.
Is there communication the employer needs to make or language they should include in plan documents?
Employers that contribute to an employee’s HSA are required to verify HDHP coverage and the employee’s age (for catch-up contributions) but are not required verify that an employee does not have other impermissible coverage, such as Medicare. However, it is good practice to provide educational materials to help employees determine whether they are eligible for an HSA. Additionally, the employer’s cafeteria plan should explain HSA eligibility and/or point the participant to IRS Publication 969.
Potential plan language we have seen is similar to: “If you elect to participate in the HSA component, you will be required to certify that you meet all the requirements under Code § 223 to be eligible to contribute to an HSA. These requirements include such things as not having any disqualifying coverage such as Medicare. You should be aware that coverage under a spouse’s plan, including a spouse’s Health FSA, could make you ineligible to contribute to an HSA. To find out more about HSA eligibility requirements and the consequences of making contributions to an HSA when you are not eligible (including possible excise taxes and other penalties), see IRS Publication 969 (Health Savings Accounts and Other Tax-Favored Health Plans) and consult with your personal tax professional.”