HSA deductions not deposited into HSA Account

[Belgarath]

Curious to know what "fix" - if any, might be available. Say an employer withheld HSA contributions in a prior year (let's say 2019). Never deposited them into the HSA. W-2 for 2019 showed the deductible HSA amounts. Now the error is discovered.

Is it just a case of "so sorry, too bad" and a revised 2019 W-2 must be done, or is there a "correction" such as depositing the HSA funds now (although I suppose the HSA custodian might not allow it anyway...)

In the 401(k) world, these things can be fixed, but I don't know about HSA's...

[Peter Gulia]

If the employer restores to each Health Savings Account the money not paid over to the HSA custodian (with an investment adjustment), might a 2019 W-2 become correct?

 

Each investment adjustment should be the greater of (i) the investment returns the HSA would have obtained by promptly investing the missing amounts and (ii) the investment return the employer obtained using the money the employer wrongfully had or the interest value of that money, whichever is greater.

 

[Belgarath]

Thanks Peter. Is there any authority/citation for this, or is this an intelligent and common sense approach?

P.S. hi Peter - this HSA thing isn't anything we have anything to do with - just a question from a retirement plan client. But I just this moment received another tidbit of information about it - apparently the HSA custodian has formally said they won't accept the 2019 contribution now, so that sort of negates your solution. Sounds like no option left other than issuing a corrected W2? (I'm going to refer them to their own tax counsel anyway...)

[Peter Gulia]

Common sense; I did not base anything on a specific statute, agency rule, or other agency interpretation.

 

My explanation about an investment adjustment is grounded on treatises describing courts’ decisions applying the common law of equity or chancery relief.  If one needs citations, a lawyer might look to the American Law Institute’s Restatements.  Also, the U.S. Labor department has described, but not in an agency rule, a similar framework for the equity concept of restoration to correct a prohibited transaction.

 

You’re right to tell the employer to lawyer-up.

 

[Luke Bailey]

I don't recall any guidance on this. The employees never got paid the money, and they are cash basis taxpayers, so it's not obvious to me why they would be taxable in 2019. The custodian is probably correct that since there is no guidance, the IRS could view the 2019 contributions contributed now as having to be counted against 2020 limits, which is why they won't do it. The alternative would be to view the employer as the custodian's agent, and they would not want to go there for a variety of reasons.

Presumably the 2019 5498-SA's did not show the contributions. I think if the contributions had been made by the employee's tax return filing deadline for 2019, the custodian would have accepted them.

Anyway, my guess is the backed up amounts are includible on W-2 when paid, but will be interested if anyone else has different thought.