HSA Audit: What Triggers It and How to Respond

An audit of a Health Savings Account (HSA) is a component of a broader Internal Revenue Service (IRS) examination of an individual’s annual tax return. The purpose of this review is to verify that all contributions, distributions, and other activities comply with tax laws. The IRS seeks to confirm that funds are being used for qualified medical expenses and that the account holder has not exceeded contribution limits.

Common Triggers for an HSA Audit

Certain activities on a tax return can signal to the IRS that a closer look at an HSA is warranted. These triggers include:

• Taking distributions in large, round numbers. These transactions do not resemble typical payments for medical services, which are for specific, uneven amounts, prompting the IRS to question whether the funds were used for non-qualified purposes.
• A mismatch between reported distributions and medical expenses. If the total distributions reported on your tax return do not appear to be offset by sufficient medical expenses, it can suggest that funds were withdrawn for non-medical reasons, inviting scrutiny.
• Contributing more than the annual limit. For 2025, the IRS limits HSA contributions to $4,300 for self-only coverage and $8,550 for family coverage. Individuals aged 55 and older can contribute an additional $1,000 as a catch-up contribution. Its presence on a return is a reason for the IRS to initiate a review.
• Taking distributions for non-medical purposes before age 65. While individuals can withdraw funds for any reason after age 65, doing so earlier for non-qualified expenses incurs both income tax and a penalty, attracting IRS attention.

Documentation and Recordkeeping Requirements

To successfully navigate an audit, meticulous recordkeeping is necessary, as the burden of proof rests on the taxpayer to substantiate every transaction. This begins with maintaining detailed proof of Qualified Medical Expenses (QMEs). Itemized receipts from healthcare providers and Explanation of Benefits (EOB) statements from insurers are the primary documents required.

These records must clearly show the patient’s name, the specific service or product received, the date of the service, and the cost. Credit card statements or canceled checks are considered insufficient as they do not provide the necessary level of detail.

Proof of contributions is also important. Each year, the financial institution that holds the HSA will issue Form 5498-SA. This form reports the total contributions made to the account for the tax year and should be kept to verify that contributions reported on the tax return match the custodian’s official records.

When funds are withdrawn, the financial institution issues Form 1099-SA, which details the gross distribution amount taken from the account. This information is transferred to Form 8889, Health Savings Accounts (HSAs), the central document for reporting all HSA activity. On Form 8889, you categorize distributions as either tax-free for medical expenses or taxable.

Navigating the Audit Process

Upon receiving a notice from the IRS, the first step is to read it carefully. The most common notice for this type of issue is the CP2000, which is a proposal of changes to a tax return. The letter will specify which part of the HSA reporting is being questioned, such as distributions that do not appear to be for qualified medical expenses.

With the IRS’s request understood, the next action is to gather the specific documentation needed to address their inquiry. This involves matching every distribution amount in question with corresponding itemized receipts, EOBs, or provider invoices. Organizing these documents chronologically or by provider can help present the information logically.

Once the supporting documents are organized, the response package must be submitted to the IRS. The notice will provide explicit instructions on how and where to send the information. This is done by mail to the address provided, and using a trackable delivery service is recommended. The IRS may also offer an option to upload documents through a secure online portal.

After submitting the response, the taxpayer should wait for the IRS to review the information. The process concludes when the IRS issues a final determination letter. This letter will either state that the information provided was sufficient and the issue is resolved, or it will detail any proposed adjustments to tax liability.

Potential Outcomes and Penalties

If an audit determines that HSA funds were used for non-qualified expenses, the consequences are significant. The amount of any non-qualified distribution is included in the taxpayer’s gross income for that year and is subject to their ordinary income tax rate. This negates the tax-free benefit of the HSA withdrawal.

Beyond the income tax, the IRS imposes an additional 20% penalty tax on the amount of any non-qualified distribution. This penalty is designed to discourage the use of HSA funds for anything other than their intended purpose. There are specific exceptions to this penalty, such as distributions made after the account holder’s death, disability, or after they have reached the age of 65.

A separate penalty applies to individuals who contribute more than the annual limit to their HSA. The IRS imposes a 6% excise tax on these excess contributions. This tax is not a one-time penalty; it applies for each year that the excess amount remains in the account. To stop the penalty, the excess contribution, along with any earnings it generated, must be withdrawn before the tax filing deadline.