What this line means
A 20% penalty tax on distributions from a Health Savings Account (HSA) that were not used for qualified medical expenses. When you withdraw money from your HSA for anything other than eligible medical costs, the withdrawn amount is included in your taxable income and hit with an additional 20% tax. You calculate this on Form 8889, Part III.
Does this apply to you?
- You withdrew money from your HSA and used it for non-medical expenses
- You used HSA funds for cosmetic surgery, gym memberships, or other expenses that do not qualify as medical expenses under IRS rules
- You took an HSA distribution and cannot document that it was used for qualified medical expenses
Easy to overlook
The 20% penalty does not apply after age 65 or upon disability Once you turn 65, you can withdraw HSA funds for any purpose without the 20% penalty. 1 The distribution is still included in taxable income (like a traditional IRA withdrawal), but the penalty disappears. The same exception applies if you become disabled. This makes HSAs a powerful retirement savings vehicle — qualified medical expenses are always tax-free, and after 65, non-medical withdrawals are taxed like regular income with no penalty. IRS Form 8889 Instructions — Health Savings Accounts
You must keep receipts to prove qualified medical expenses The IRS does not require you to submit documentation with your return, but you must be able to substantiate that HSA distributions were used for qualified medical expenses if audited. 2 Save receipts for every medical expense paid from your HSA. If you cannot prove the expense was qualified, the distribution is treated as non-medical and subject to both income tax and the 20% penalty. General filing pattern — HSA used for non-qualified expenses
Watch out for this
Assuming all health-related expenses are qualified. Common expenses that do not qualify include health insurance premiums (with limited exceptions), over-the-counter cosmetics, teeth whitening, and gym memberships. If you pay for a non-qualified expense with your HSA debit card, you owe income tax plus the 20% penalty on that amount. Check IRS Publication 502 before using HSA funds for borderline expenses.
Footnotes
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IRS Form 8889 Instructions, Part III, Additional Tax. https://www.irs.gov/instructions/i8889 ↩
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IRS Publication 969, Health Savings Accounts, Recordkeeping. https://www.irs.gov/pub/irs-pdf/p969.pdf ↩