IRS Clarifies When Employers Can Recoup Erroneous HSA Contributions
The Internal Revenue Service (IRS) recently issued an informational letter clarifying when employers can seek the return of contributions mistakenly made to an employee’s health savings account (HSA) due to an administrative or processing error. HSAs are tax-favored accounts available to individuals covered by high-deductible health plans (HDHPs) that are used to pay certain medical expenses. HSAs are not employer-sponsored health plans and are generally funded by employee salary reductions through a cafeteria plan or through deductible after-tax contributions by the employee. However, employers are also permitted to contribute to an HSA on a tax-advantaged basis for its employees, provided that such contributions must be nonforfeitable and not cause the HSA to exceed the annual contribution limit ($3,500 for self-only coverage and $7,000 for family coverage in 2019).
Employers have historically struggled with how to handle mistakes related to HSA contributions, particularly when the error results in giving the employee excess contributions, because the Internal Revenue Code provides that an individual’s interest in their HSA is nonforfeitable. The IRS’s informational letter provides helpful guidance for employers regarding how and when amounts contributed to employees’ HSAs by mistake may be recouped by the employer.
Previous IRS Guidance Was Very Limited
In Notice 2008-59 (released in June 2008), the IRS laid out limited circumstances in which an employer may recoup employee or employer contributions to an employee’s HSA depending on the type of mistake that occurred. For example, if an employee was never eligible to contribute to an HSA (e.g., they weren’t covered by a HDHP) or if the employer made contributions in excess of the statutory limit, the employer could request that the financial institution return the amounts mistakenly contributed. The Notice also provided that employers could not recoup erroneous contributions due to an employee who ceased to be an eligible individual during the year or if the contributions did not exceed the statutory maximum.
Given the limited circumstances in which IRS Notice 2008-59 allows HSA corrections, employers and their advisors generally interpreted the guidance narrowly, only allowing corrections of mistaken HSA contributions that fell within one of the scenarios in which corrections are specifically allowed.
New Guidance Expands & Clarifies Prior Guidance
The IRS clarified in Informational Letter 2018-0033 that the circumstances discussed in Notice 2008-59 were not intended to provide an exclusive set of circumstances in which an employer may request the return of HSA contributions. Rather, if there is clear documentary evidence demonstrating that amounts contributed were the result of the employer’s or trustee’s administrative or process errors, employers may request that those amounts be returned. All such corrections must be crafted to ensure that the parties are put in the same position that they would have been in had the error not occurred.
The IRS also gave examples of errors that may be corrected under the standard described above. These examples are in addition to those addressed in Notice 2008-59, and include:
- An amount withheld and deposited in an employee’s HSA for a pay period that is greater than the amount shown on the employee’s HSA salary reduction election;
- An amount that an employee receives as an employer contribution that the employer did not intend to contribute but was transmitted because an incorrect spreadsheet is accessed or because employees with similar names are confused with each other;
- An amount that an employee receives as an HSA contribution because it is incorrectly entered by a payroll administrator (whether in-house or third-party) causing the incorrect amount to be withheld and contributed;
- An amount that an employee receives as a second HSA contribution because duplicate payroll files are transmitted;
- An amount that an employee receives as an HSA contribution because a change in employee payroll elections is not processed timely so that amounts withheld and contributed are greater than (or less than) the employee elected;
- An amount that an employee receives because an HSA contribution amount is calculated incorrectly (e.g., if an employee elects a total amount for the year that is allocated by the system over an incorrect number of pay periods); and
- An amount that an employee receives as an HSA contribution because the decimal position is set incorrectly resulting in a contribution greater than intended.
What This Means for Employers
Despite what many of us thought, the IRS more generously interpreted its own guidance and recognizes that administrative or processing errors should be correctable in a broad range of circumstances. Employers managing their own payroll practices should regularly review their processes to ensure that employee salary reductions and HSA contributions are being accurately implemented. Employers that rely on third parties for these services should discuss the implications of the IRS’s guidance with their service provider and assess whether changes to the service provider’s processes are warranted.
When errors relating to employees’ HSA contributions arise, employers should confer with their advisor or ERISA counsel to assess whether they are eligible to take corrective action under the new IRS guidance. It is critically important that employers making corrections maintain sufficient documentation to support any assertion that a mistaken contribution occurred, as well as documentation of its corrective actions.
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