We have a customer who contacted us because she received her 1099-SA and said it was not correct. It was showing a distribution of $200 and she stated it should be around $2200.00. After some research, we realized that the 1099-SA was also reporting a code 5 - prohibited transaction. This was because the account became overdrawn 1 time during the month of June. This was due to a debit card purchase that was approved at the time of purchase, but by the time it actually cleared the account, the funds were no longer in the account to cover it. At this point, there really isn't anything for us to do with this purchase, other than honor it. We talked to a gentleman in the retirement help call center at our forms vendor. He basically stated that we must correct this because it was our fault for allowing the account to become overdrawn. My question is, how does it become our fault if we can't stop the charge from posting? And if this is the case, then would every HSA account that becomes overdrawn be the banks fault and have to be corrected and re-submitted to the IRS?

Another question I have is - if an HSA account becomes overdrawn and then becomes prohibited - is this only for the year of the overdraft? Or should we close the account entirely or transfer it to a regular checking account? The customer is wanting this fixed today and we are confused as to how to handle this.

Thanks!

Paying an HSA into the overdraft is a prohibited transaction regardless of the circumstance. The bank lent money to the HSA which cannot be done and since there was a prohibited transaction, it basically nullifies the HSA and the bank is likely liable. You need to sit down with an IRS attorney and figure out your next steps to mitigate your risk and establish procedures going forward. Banks will process these OD transactions outside of an HSA and collect these monies on the side from the customer to avoid this issue.