Why Is My HSA Being Taxed? Withdrawals, Limits, and Rollovers

Your HSA is being taxed because something broke the tax-advantaged rules the account depends on. The usual reasons: you spent the money on something the IRS doesn’t consider a qualified medical expense, you contributed more than the annual limit, you lost your high-deductible health plan (HDHP) coverage after using a special contribution shortcut, you enrolled in Medicare, you mishandled a rollover, you inherited the account as someone other than a spouse, or you live in a state that doesn’t recognize the federal HSA tax break. Each of these creates a different tax bill, and the most expensive one — a non-qualified withdrawal before age 65 — hits you with both income tax and a 20% penalty on the amount you took out.¹

You Spent HSA Money on Something Non-Medical

This is the most common reason an HSA shows up as taxable. When you use HSA funds for anything other than a qualified medical expense, two taxes apply. The full withdrawal is added to your taxable income for the year, so you owe ordinary income tax on it. The IRS also imposes an additional 20% penalty on the same amount.¹ In the 22% federal bracket, a $5,000 withdrawal for a vacation costs roughly $2,100 in combined tax and penalty.

The 20% penalty goes away at age 65, or upon disability or death. After 65, the HSA behaves like a traditional IRA for non-medical spending: withdrawals are still taxed as ordinary income, but the extra 20% no longer applies.¹ Below 65 and not disabled, the penalty applies no matter the reason.

Distributions are reported on Form 8889 with your tax return. Part II is where you show which portion of your distributions was qualified and which wasn’t.²

What Actually Counts as a Qualified Medical Expense

Qualified expenses are defined under IRC Section 213(d) and cover diagnosis, treatment, and prevention of disease.³ Doctor visits, hospital stays, prescriptions, dental, vision, copays, and deductibles qualify. The expense also has to have been incurred after the HSA was established.

Health insurance premiums are where people usually get caught. Paying your regular monthly health plan premium from the HSA is almost always a non-qualified distribution. Premiums only qualify in a few situations: COBRA continuation, coverage while receiving unemployment, Medicare (Parts A, B, D, and Medicare Advantage), and qualified long-term care insurance.⁴ Cosmetic procedures that aren’t medically necessary also don’t qualify.

Documentation matters. The IRS doesn’t ask for receipts when you take a distribution, but in an audit you need to show every withdrawal went toward an eligible expense. Without records, the IRS can reclassify the distribution as non-qualified and assess income tax plus the 20% penalty.

You Contributed More Than the Annual Limit

For 2026, contribution limits are $4,400 for self-only HDHP coverage and $8,750 for family coverage.⁵ If you’re 55 or older, add a $1,000 catch-up. These limits include what your employer contributes, not just what you put in. Anything above the limit is an excess contribution.

Excess contributions aren’t taxed as ordinary income on their own, but they carry a 6% excise tax for every year the excess stays in the account.⁶ It repeats. A $1,000 excess left untouched costs $60 this year, $60 next year, and so on until you fix it.

The fix: withdraw the excess along with any earnings it generated before your tax filing deadline, including extensions. The principal isn’t taxed when removed in time, but the earnings on it are included in your gross income for that year.¹ Miss that deadline and the 6% excise tax gets reported on Form 5329 each year until the excess is resolved.⁷

Excess contributions sneak in when you change jobs mid-year and both employers contribute, or when you shift between self-only and family coverage. If you weren’t covered by an HDHP for the entire year, your contribution limit is prorated by the number of eligible months. That prorating catches a lot of people.

You Used the Last-Month Rule and Then Lost Eligibility

The last-month rule lets you contribute the full annual amount if you’re HSA-eligible on December 1, even if you weren’t eligible earlier in the year.² The condition: you have to stay HSA-eligible through the entire 13-month testing period, running from December 1 through December 31 of the following year.

Lose eligibility during that window — switch to a non-HDHP plan in March, drop coverage — and the extra contributions you made under the last-month rule get added back to your gross income. A 10% additional tax applies to that amount.⁴ The only exceptions are death and disability. This is calculated on Part III of Form 8889.

You Enrolled in Medicare

Working past 65 creates its own trap. Enrolling in Medicare Part A or Part B ends your HSA contribution eligibility. Your monthly limit drops to zero, even while you’re still on an HDHP through your employer. Anything you contribute after Medicare starts is an excess contribution, subject to the 6% annual excise tax.⁶

The backdate is what surprises people. If you delay enrolling in Part A and later sign up, coverage is automatically backdated by up to six months. Contributions you made during those six months become excess contributions retroactively, even though you weren’t enrolled at the time. If you’re planning to enroll after 65, stop HSA contributions at least six months before your enrollment date.

Spending the existing balance is fine. You can still use HSA funds tax-free for qualified medical expenses after Medicare enrollment, and Medicare premiums for Parts A, B, and D are themselves qualified expenses.⁴ The restriction is on new contributions.

Your IRA-to-HSA Rollover Fell Apart

The tax code allows a one-time transfer from a traditional IRA to your HSA. Done correctly, it moves retirement funds into a tax-free medical account with no income tax or early withdrawal penalty. The transfer is capped at your annual HSA contribution limit and counts against that year’s limit.

The same kind of testing period applies. You must stay HSA-eligible for 12 months from the month of the transfer. Lose HDHP coverage during that window and the entire rollover amount is added to your taxable income, plus a 10% additional tax.¹ That’s 10%, not the 20% that applies to regular non-qualified distributions. Death and disability are the only exceptions.

The move only makes sense when you’re confident your HDHP coverage will hold for a full year. A job change, a marriage that puts you on a spouse’s non-HDHP plan, or Medicare eligibility during the testing period would all trigger the tax.

You Missed the 60-Day Window on an HSA Rollover

Moving money between two HSAs comes in two forms: a direct trustee-to-trustee transfer, where you never touch the funds, and an indirect rollover, where the money comes to you and you redeposit it.

An indirect rollover gives you 60 days from receipt to deposit the funds into the new HSA. Miss it and the IRS treats the whole amount as a taxable distribution. Since it wasn’t spent on qualified medical care, it hits your gross income and, if you’re under 65, carries the 20% penalty.¹ You’re also limited to one indirect HSA rollover every 12 months. A direct transfer has no 60-day deadline and no annual limit, which is why it’s the safer route.

You Inherited the HSA and You’re Not the Spouse

What happens after the account owner dies depends entirely on the beneficiary. A spouse named as beneficiary simply takes over the HSA. No tax is owed, and the account keeps its status.⁸

For any other beneficiary — a child, sibling, or the estate — the account stops being an HSA on the date of death. The full fair market value is treated as taxable income to the beneficiary in the year the account holder died.⁸ A sizable balance can push a non-spouse beneficiary into a higher bracket in a single year.

One offset: the taxable amount is reduced by any qualified medical expenses the deceased incurred before death that the beneficiary pays within one year afterward.⁸ The 20% penalty does not apply to distributions triggered by the account holder’s death, regardless of the beneficiary’s age.

Your State Doesn’t Follow the Federal HSA Rules

You can do everything right at the federal level and still get taxed by your state. The triple tax advantage — deductible contributions, tax-free growth, tax-free qualified withdrawals — is a federal treatment. A few states don’t conform. In those states, HSA contributions aren’t deductible on your state return, and investment earnings inside the account are taxable at the state level every year.

HSA custodians generally don’t issue state-specific tax forms for the interest, dividends, and capital gains inside the account. If your state taxes HSA earnings, you have to pull those figures from your account statements and report them yourself. State agencies don’t receive automatic reporting of what’s happening inside the HSA, so accuracy is on you. Check your state’s rules before assuming the federal break carries over.

1
Office of the Law Revision Counsel. 26 USC 223 – Health Savings Accounts
2
Internal Revenue Service. Instructions for Form 8889 – Health Savings Accounts (HSAs)
3
Office of the Law Revision Counsel. 26 US Code 213 – Medical, Dental, Etc., Expenses
4
Internal Revenue Service. Publication 969 – Health Savings Accounts and Other Tax-Favored Health Plans
5
Internal Revenue Service. Revenue Procedure 2025-19
6
Office of the Law Revision Counsel. 26 USC 4973 – Tax on Excess Contributions to Certain Tax-Favored Accounts and Annuities
7
Internal Revenue Service. Instructions for Form 5329
8
Office of the Law Revision Counsel. 26 US Code 223 – Health Savings Accounts