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HSA Mistaken Contributions

By Brian Gilmore | Published July 31, 2020

Question: When can an employer have mistaken HSA contributions returned by the HSA custodian?

Short Answer: Although the general rule is that all employer HSA contributions are nonforfeitable, there are three situations that permit employers to correct an error by requesting the HSA custodian return mistaken contributions.

General Rule: HSA Contributions are Nonforfeitable

The general rule is that an employer cannot recoup any portion of its contributions to the employee’s HSA.

This means there can’t be any vesting schedule or other conditions on amounts contributed to the HSA. If an employee terminates, the HSA contributions will always remain in the employee’s account with no opportunity for the employer to have those funds returned.

Example 1:

• David’s employer funds HSA contributions once per calendar year on January 1.
• David terminates employment on January 2, 2020 after receiving the full calendar plan year employer HSA contribution of $3,000 on January 1, 2020.

Result 1:

• David’s employer cannot recover any of the nonforfeitable $3,000 HSA contribution made on January 1—even though David terminated employment the next day.
• Note: David must be careful to avoid excess contributions in this situation.

Mistaken Contribution Exception #1: Employee Was Never HSA-Eligible

If an employer contributes to the HSA of an employee who was never HSA-eligible, the IRS takes the position that the HSA never actually existed because it was not properly established. In that case, the employer can correct the error before the end of the calendar year by requesting that the HSA custodian return the contributions (adjusted for earnings and administrative fees) back to the employer.

Assuming the custodian agrees to return the funds, the employer should process the correction as follows:

• Mistaken Employer Contributions: Retained by the employer;
• Mistaken Employee Contributions: Returned to the employee as taxable income subject to withholding and payroll taxes.

Note that this correction method is available only if the employee was never HSA-eligible. In other words, if the contributions were mistaken because the employee lost HSA eligibility mid-year, the contributions remain nonforfeitable.

Example 2:

• On January 1, 2020, Sarah’s employer contributed $3,000 to her “HSA” despite not enrolling in the HDHP.
• $2,000 of the contributions were employer contributions, $1,000 of the contributions were employee pre-tax contributions through payroll.
• In July 2020, the employer learns that Sarah’s account is not an HSA because Sarah was never HSA-eligible.

Result 2:

• The employer retains the $2,000 in mistaken employer contributions with no tax consequences to Sarah.
• The employer refunds the $1,000 in mistaken employee contributions to Sarah as standard taxable income subject to withholding and payroll taxes.

Example 3:

• Same as Example 2, but Sarah’s employer does not discover the error until March 2021.

Result 3:

• The employer must issue a corrected 2020 Form W-2c to Sarah to include the mistaken contributions in Sarah’s gross income.
• If Sarah already filed her individual return, she will need to file an amended return (generally via Form 1040X) to report the additional income.

Mistaken Contribution Exception #2: Employer Contributions Exceed Statutory Limit

If an employer contributes to an employee’s HSA in excess of the statutory annual maximum contribution limit, the employer may correct the error. The correction can be made before the end of the calendar year by requesting that the HSA custodian return the excess contributions (adjusted for earnings and administrative fees) back to the employer.

Assuming the custodian agrees to return the excess funds, the employer should process the correction as follows:

• Excess Employer Contributions: Retained by the employer;
• Excess Employee Contributions: Returned to the employee as taxable income subject to withholding and payroll taxes.

Example 4:

• Tiffany has family HDHP coverage in 2020.
• In December 2020, Tiffany’s employer discovers that the employer contributions to her HSA total $7,200 (due to a mistaken excess employer contribution).
• The employer requests that the HSA custodian return the $100 excess contributions (adjusted for earnings plus administrative fees) to the employer.

Result 4:

• The employer retains the $100 in mistaken employer contributions with no tax consequences to Tiffany.

Example 5:

• Same as Example 4, but Tiffany’s employer does not discover the error until March 2021.

Result 5:

• The employer must issue a corrected 2020 Form W-2c to Tiffany to include the mistaken contributions in Tiffany’s gross income.

Mistaken Contribution Exception #3: Clear Documentary Evidence of an Administrative or Process Error

This third exception allows employers to correct errors by requesting that the HSA custodian return the mistaken contributions (adjusted for earnings and administrative fees) back to the employer when there is clear documentary evidence demonstrating that an error occurred.

Assuming the custodian agrees to return the mistaken contributions, the employer should process the correction as follows:

Example 6:

• Eric has employee-only HDHP coverage in 2020.
• The employer’s policy mistakenly contributes $3,000 to his HSA instead of the correct amount.

Result 6:

• The employer retains the $1,500 in mistaken employer contributions with no tax consequences to Eric.

Regulations

IRC §223(d)(1)(E):

(E) The interest of an individual in the balance in his account is nonforfeitable.

IRS Notice: 2004-50, Q/A-82:

Q-82. May the employer recoup from an employee’s HSA any portion of the employer’s contribution to the employee’s HSA? A-82. No. Under section 223(d)(1)(E), an account beneficiary’s interest in an HSA is nonforfeitable.

IRS Information Letter 2018-0033:

Notice 2008-59 does not specifically address other situations in which contributions to an employee’s HSA are the result of the employer’s or trustee’s administrative or process errors. However, if there is clear documentary evidence demonstrating that a mistaken contribution occurred, the employer may request that the financial institution return those amounts.