HSA Distribution Codes on Form 1099-SA Explained

A Health Savings Account (HSA) provides a tax-advantaged way to save for medical costs. When you withdraw money from your HSA, it is known as a distribution. These distributions are categorized for tax reporting to determine if they are tax-free or if they are subject to income tax and potential penalties. Understanding how these transactions are classified is part of managing your health savings.

Understanding Form 1099-SA

Financial institutions that hold HSA funds are required to issue Form 1099-SA, “Distributions From an HSA, Archer MSA, or Medicare Advantage MSA,” to both the account holder and the IRS. You can expect to receive this form by January 31st of the year following any distributions.

The form details information needed for your tax return. Box 1, labeled “Gross distribution,” shows the total amount withdrawn, regardless of how the funds were used. Box 3 contains a single-digit “Distribution code,” which tells the IRS the circumstances of the withdrawal and is the focus of tax reporting.

The Distribution Codes Explained

The number in Box 3 of your Form 1099-SA provides the initial context for the distribution to the IRS. Each code signifies a specific reason for the withdrawal, which influences how it is treated for tax purposes. Understanding your specific code is important before preparing your tax return.

Code 1 – Normal Distribution

Code 1 is the most common and is used for any normal distribution paid to you or directly to a medical provider. This code is a default category used when no other specific circumstance applies. Its presence does not automatically mean the distribution is tax-free, as taxability depends on whether the funds were used for qualified medical expenses defined by the IRS in Publication 502.

Code 2 – Excess Contributions

This code indicates that you have withdrawn excess contributions from your account, which occurs if you or your employer contributed more than the annual limit set by the IRS. To avoid a 6% excise tax, these excess amounts, along with any earnings they generated, must be removed by the tax filing deadline. Box 2 of Form 1099-SA reports the earnings on these excess contributions, which are considered taxable income.

Code 3 – Disability

Code 3 is used if you took a distribution from your HSA after becoming disabled. If you are under age 65 and disabled, distributions for non-medical expenses are taxable but are not subject to the additional 20% penalty that applies to non-qualified withdrawals. This code signals that specific circumstance to the IRS.

Code 4 – Death

This code is for distributions made to a beneficiary following the death of the account holder. If the beneficiary is the surviving spouse, the HSA is treated as their own. For a non-spouse beneficiary, distributions made in the year of death are reported with this code, and the account’s fair market value becomes taxable income to them. The beneficiary can reduce the taxable amount by using the funds for the deceased’s qualified medical expenses within one year of the death. Box 4 of the form shows the fair market value of the account on the date of death.

Code 5 – Prohibited Transaction

A Code 5 indicates that a prohibited transaction occurred, such as borrowing from or pledging the account as security for a loan. If this happens, the account is treated as being distributed on the first day of the year the transaction occurred. The entire amount is considered taxable income and may be subject to penalties.

Code 6 – Death Distribution

This code is also used for a death distribution, but it specifically applies to payments made to a non-spouse beneficiary in the year after the year of the account holder’s death. This distribution is taxable income to the beneficiary.

Reporting Distributions on Your Tax Return

After receiving Form 1099-SA, you must report the distribution to the IRS using Form 8889, “Health Savings Accounts (HSAs),” which is filed with your Form 1040. This form reconciles your HSA distributions with your medical spending to determine if any portion of your withdrawal is taxable.

You will transfer the gross distribution from Box 1 of Form 1099-SA to Line 14a of Form 8889. On Line 15, you enter your total unreimbursed qualified medical expenses. If your distribution on Line 14a is less than or equal to your expenses on Line 15, the distribution is tax-free. If the distribution exceeds your expenses, the difference is calculated on Line 16 as taxable income and carried to your Form 1040. This amount may also be subject to a 20% penalty, calculated on Line 17b.

Correcting an Incorrect Code

If you believe the distribution code on your Form 1099-SA is incorrect, contact the HSA custodian that issued the form. An incorrect code can lead to improper taxation or penalties. Explain why you believe the code is in error and provide supporting documentation, such as medical receipts or proof of a rollover.

The goal is to have the institution issue a corrected Form 1099-SA. If the custodian agrees, they will send a new form to both you and the IRS. If you cannot get a corrected form before the tax filing deadline, file your return with the information you believe is correct and attach a statement explaining the discrepancy.