How Severe is an HSA Audit?

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impguard
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How Severe is an HSA Audit?

Post by impguard » Mon Jan 09, 2017 3:37 pm

Was reading up on some HSA information to understand how I could use it as a investment vehicle (what receipts I should/could save) and I was curious about the severity of an audit.

In terms of an HSA, there are certain things you're allowed to reimburse and some things you're not. I was curious as to how severe the punishment would be if you accidentally reimbursed things you technically should not. For example, let's say I have a few legitimate doctor visits that costs some large amount, then I accidentally included some vitamins I purchased (which I don't think is allowed for reimbursement). Would an audit be:

1. Pay back the amount you shouldn't have received back to your HSA account or to the government as a penalty?
2. Get punished for breaking the rules and pay a huge penalty?
3. A slap on the wrist but everyone understands that mistakes happen?

This assumes of course, that your "accidents" aren't a huge chunk of your reimbursements.

As an addendum:

How detailed do your receipts need to be to be safe for an audit? Should I ask my doctors/urgent cares to give me a proper itemized receipt? They usually just give a simple receipt with a dollar value. They also typically recommend me get some items off the shelf, should I get a written note for everything they suggest?

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Re: How Severe is an HSA Audit?

Post by BolderBoy » Mon Jan 09, 2017 4:12 pm

I have not had an HSA audit. My understanding is that any monies removed from an HSA account (for any reason) that are not, or have not been, spent on legitimate healthcare needs, are taxed at your marginal tax rate.

So an audit may find you owe back taxes (perhaps interest) and if the $$$ amount rises to such level, underpayment penaties.
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billern
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Re: How Severe is an HSA Audit?

Post by billern » Mon Jan 09, 2017 4:21 pm

Distributions without qualifying expenses are taxable (ie: taxed at your marginal rate), plus there is a 20% Federal excise tax.

There would also be some fairly minimal interest and penalty on the understated income / unpaid tax. If it is a substantial income understatement, there are more significant penalties (accuracy, fraud related) that might apply. It would have to be substantial in terms of your income to get those.

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Re: How Severe is an HSA Audit?

Post by Spirit Rider » Mon Jan 09, 2017 4:30 pm

Non-qualified distributions are taxable as ordinary income and subject to a 20% penalty and if this is for prior years there will be failure to pay penalties. You do not restore the distributions. Who knows how a given audit is going to treat specific circumstances.

You are required to substantiate both that the expense was qualified and was paid. There needs to be enough information to establish both. Probably doctors bills, EOBs, pharmacy & store receipts, etc... for expenses and HSA account, checking account and/or credit card account payment records.

impguard
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Re: How Severe is an HSA Audit?

Post by impguard » Mon Jan 09, 2017 4:57 pm

Jeez that's a lot of work. I guess I should have my doctor give me an itemized receipt.

Thanks!

Alan S.
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Re: How Severe is an HSA Audit?

Post by Alan S. » Mon Jan 09, 2017 6:39 pm

When tax preparers joke about the nightmare client, they often refer to the person who brings all their unorganized and uncategorized receipts in a shoebox and drops it on the preparer's desk. :twisted:

Now picture the year 2050 when you start reimbursing yourself for this year's medical costs you paid from other than HSA distributions, and of course did not itemize. The tax preparer will take your word for it, and if the IRS wants to question the numbers, then guess who deals with 34 years of shoe box receipts? No, the IRS is not going to ask you to bring the receipts into an IRS office, but well before 2050 they will probably realize the issues this creates.

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Re: How Severe is an HSA Audit?

Post by mikep » Mon Jan 09, 2017 6:58 pm

Alan S. wrote:When tax preparers joke about the nightmare client, they often refer to the person who brings all their unorganized and uncategorized receipts in a shoebox and drops it on the preparer's desk. :twisted:

Now picture the year 2050 when you start reimbursing yourself for this year's medical costs you paid from other than HSA distributions, and of course did not itemize. The tax preparer will take your word for it, and if the IRS wants to question the numbers, then guess who deals with 34 years of shoe box receipts? No, the IRS is not going to ask you to bring the receipts into an IRS office, but well before 2050 they will probably realize the issues this creates.
This is exactly why I have started reimbursing myself from my HSA. I'm a few years behind though.
34 years of shoebox receipts, and 34 years of tax returns to show you didn't itemize or reimburse from the HSA in those years. Yikes.
To add, the burden of proof is always on the taxpayer to defend an audit. Guilty until proven innocent.
They can always change the HSA rules in the future as well, such as expenses more than 2-3 years earlier are non-reimbursable.

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Re: How Severe is an HSA Audit?

Post by TimeRunner » Mon Jan 09, 2017 7:23 pm

mikep wrote:This is exactly why I have started reimbursing myself from my HSA....
Me too. Last year I reimbursed myself for 2012-10/2016 qualified medical expenses then began charging them to the HSA account going forward. Hopefully the account will last at least another four or five years before it's emptied.
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Re: How Severe is an HSA Audit?

Post by Spirit Rider » Mon Jan 09, 2017 7:30 pm

It doesn't have to be an all or nothing choice. The 80:20 rule has many applications, this might be one. Reimburse the large number small qualified expenses (prescriptions, reading glasses, etc...), leaving a small number of larger expenses.

This leaves you with a much smaller number of expenses/receipts to track while allowing the vast majority of the assets to be preserved for long term investing.

If they ever do limit the amount of time you can wait to reimburse, there will be a transition period.

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Re: How Severe is an HSA Audit?

Post by Johnny Thinwallet » Mon Jan 09, 2017 7:42 pm

We've had an HSA since 2014, and we just reimbursed ourselves in December for expenses from 2014 through first half of 2016. Most of the expenses were for small things like prescriptions. This enabled me to clean out about 20 line item receipts that I can file away with my 2016 taxes rather than worrying about saving and tracking in the future.

Moving forward, I plan to reimburse ourselves periodically in this same manner.

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Re: How Severe is an HSA Audit?

Post by Artsdoctor » Mon Jan 09, 2017 8:54 pm

impguard,

In reference to your bookkeeping, I'd try to maintain reasonable documentation. You probably get a bill when you go to the doctor. If you paid cash, then write that on the bill and file it (document how you paid for it). If it went through your insurance, you probably have an EOB; you'll ultimately have a bill with the balance, and keep that with the other paperwork with the documentation that you've paid and how.

I keep the prescription bill and the receipt of being paid.

Regarding over-the-counter medication, you're pretty limited. If the doctor wants you to buy something that is not a prescription, then have him/her write it on the prescription pad anyway, and attach it to the over-the-counter receipt.

Depending on your situation, you can also reimburse for transportation expense. Obviously, if your doctor is one mile away, it's not worth it. But sometimes you have to travel a bit.

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Artsdoctor
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Re: How Severe is an HSA Audit?

Post by Artsdoctor » Mon Jan 09, 2017 9:01 pm

mikep wrote:
Alan S. wrote:When tax preparers joke about the nightmare client, they often refer to the person who brings all their unorganized and uncategorized receipts in a shoebox and drops it on the preparer's desk. :twisted:

Now picture the year 2050 when you start reimbursing yourself for this year's medical costs you paid from other than HSA distributions, and of course did not itemize. The tax preparer will take your word for it, and if the IRS wants to question the numbers, then guess who deals with 34 years of shoe box receipts? No, the IRS is not going to ask you to bring the receipts into an IRS office, but well before 2050 they will probably realize the issues this creates.
This is exactly why I have started reimbursing myself from my HSA. I'm a few years behind though.
34 years of shoebox receipts, and 34 years of tax returns to show you didn't itemize or reimburse from the HSA in those years. Yikes.
To add, the burden of proof is always on the taxpayer to defend an audit. Guilty until proven innocent.
They can always change the HSA rules in the future as well, such as expenses more than 2-3 years earlier are non-reimbursable.
I know, I know. I started really thinking about this, and I ultimately decided that I'd start to slowly reimburse myself. I'm approaching 60, and I had hoped to wait until I'm no longer working, but the reimbursements will start off small. Last year, I reimbursed myself for 2005 expenses. This year, it will be for 2006 expenses. The expenses will steadily increase (as we aged, oddly enough). You should keep those receipts for three years after you submit your tax return.

jebmke
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Re: How Severe is an HSA Audit?

Post by jebmke » Mon Jan 09, 2017 9:09 pm

I had an "audit" of my HSA (and Schedule A) one year. They asked for all documents supporting all entries on Form 8889 and Schedule A. It was a letter request, not an in-person audit.
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Re: How Severe is an HSA Audit?

Post by outdoorsygal » Mon Jan 09, 2017 9:14 pm

As stated, you will be taxed at marginal tax rate + 20% for the unqualified withdrawls.

[OT comments removed by admin LadyGeek]

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Re: How Severe is an HSA Audit?

Post by LadyGeek » Mon Jan 09, 2017 9:37 pm

I removed some OT comments regarding proposed changes in health care law. As a reminder, see: Re: Tax exempt muni bond funds & proposed lower rates on taxable investment interest

The important point is to "keep investors from making bad decisions. Proposed regulations change many times between the time they're introduced and signed into law."
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desiderium
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Re: How Severe is an HSA Audit?

Post by desiderium » Mon Jan 09, 2017 10:14 pm

You may not end up needing these old and small expense receipts in later years, because there will probably be much larger, contemporary expenses to document HSA withdrawals

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Re: How Severe is an HSA Audit?

Post by *3!4!/5! » Tue Jan 10, 2017 4:09 am

mikep wrote:
Alan S. wrote:When tax preparers joke about the nightmare client, they often refer to the person who brings all their unorganized and uncategorized receipts in a shoebox and drops it on the preparer's desk. :twisted:

Now picture the year 2050 when you start reimbursing yourself for this year's medical costs you paid from other than HSA distributions, and of course did not itemize. The tax preparer will take your word for it, and if the IRS wants to question the numbers, then guess who deals with 34 years of shoe box receipts? No, the IRS is not going to ask you to bring the receipts into an IRS office, but well before 2050 they will probably realize the issues this creates.
This is exactly why I have started reimbursing myself from my HSA. I'm a few years behind though.
34 years of shoebox receipts, and 34 years of tax returns to show you didn't itemize or reimburse from the HSA in those years. Yikes.
To add, the burden of proof is always on the taxpayer to defend an audit. Guilty until proven innocent.
They can always change the HSA rules in the future as well, such as expenses more than 2-3 years earlier are non-reimbursable.
I don't see how you could really prove what you need to prove without the entire 34 years of records, even if you are partially or fully reimbursing yourself with HSA distributions during that time. When you take an HSA distribution for $X, whose to say whether it's for a qualified expense from yesterday or many years ago. You might need to prove that the running total of HSA distributions up to any point in time never exceeds the running total of qualified expenses up to that same point in time. (Even if you take an HSA distribution every January for the previous year's total qualified expenses, you could potentially need your entire "34" years of records!

Alternatively you could say that you'll discard any tax returns older than 3 years, and discard any associated documents and receipts, including those for HSA purposes.
https://www.irs.gov/businesses/small-bu ... ep-records
This could be workable, but in effect you'd obviously be giving up any chance of claiming on the discarded receipts, effectively making older expenses non-reimbursable (so you should claim them before they "expire"). But really, I only think this can be totally foolproof if you claim expenses in the same calendar(tax) year they are incurred (e.g. once each December, not even the following January).

Actually, if Year N is the last year that the IRS can audit, then you should be okay if you can demonstrate that: For any point in time T no earlier that 1st Jan in Year N, the running total of HSA distributions from 1st Jan in Year N to time T, does not exceed the running total of qualified expenses from 1st Jan in Year N to time T.

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Re: How Severe is an HSA Audit?

Post by neilpilot » Tue Jan 10, 2017 11:42 am

I'm hijacking this thread with a slightly different question regarding HSA audits. The year I retired, I started Medicare Part A 2-3 months before I dropped my employer's health coverage, so made HSA contributions during that 2-3 month period. How likely is it that an audit will match my HSA part-year contributions against part-year Medicare A coverage?

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Re: How Severe is an HSA Audit?

Post by mcraepat9 » Tue Jan 10, 2017 11:57 am

I'm surprised this is a large burden, I just keep a cloud file with scanned receipts and a running tally of how much in HSA-eligible expenses I have incurred. If you do it correctly and contemporaneously the first time, you just need to look at the bottomline number when withdrawing.
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Re: How Severe is an HSA Audit?

Post by pshonore » Tue Jan 10, 2017 12:02 pm

neilpilot wrote:I'm hijacking this thread with a slightly different question regarding HSA audits. The year I retired, I started Medicare Part A 2-3 months before I dropped my employer's health coverage, so made HSA contributions during that 2-3 month period. How likely is it that an audit will match my HSA part-year contributions against part-year Medicare A coverage?
It depends on how thorough the auditor wants to be. They tend to spend the majority of time on cases that yield the biggest return. They do have a record of your contributions and its not hard to determine when you started Medicare A. It's extremely unlikely you would be selected for an HSA audit but one never knows. I don't think it would be difficult to run an computerized scan to compare new Part A participants who also made HSA contributions but there likely bigger fish to fry. As an example, a few years back the IRS announced that several thousand people who paid Mortgage Interest exceeding $10K (Form 1098 supplied by Banks) did not file returns. Now there are certainly some valid reasons for not filing in that situation but there is also likely some tax evasion as well.

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Re: How Severe is an HSA Audit?

Post by *3!4!/5! » Tue Jan 10, 2017 12:57 pm

mcraepat9 wrote:I'm surprised this is a large burden, I just keep a cloud file with scanned receipts and a running tally of how much in HSA-eligible expenses I have incurred. If you do it correctly and contemporaneously the first time, you just need to look at the bottomline number when withdrawing.
One big problem is that with most medical providers it is virtually impossible to attribute a specific payment to a specific service. They will only keep a running tally of what they think you owe and what they think you paid. So any particular payment can never be associated with a particular date of service, and that really opens up a can of worms. At the least, you can keep running tallies of what you owe and what you paid separately for each provider, but you can not separate out the individual instances of service.

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Re: How Severe is an HSA Audit?

Post by Spirit Rider » Tue Jan 10, 2017 1:14 pm

neilpilot wrote:I'm hijacking this thread with a slightly different question regarding HSA audits. The year I retired, I started Medicare Part A 2-3 months before I dropped my employer's health coverage, so made HSA contributions during that 2-3 month period. How likely is it that an audit will match my HSA part-year contributions against part-year Medicare A coverage?
There may be a bigger problem. If you were older than 65 when you enrolled in Medicare. You were automatically enrolled in Medicare Part A retroactively up to 6 months, but not earlier than 65. This retroactive enrollment makes you retroactively ineligble for HSA contributions for those months. If you were >= 65 1/2, then you have 8-9 months of excess contributions.

Here at Bogleheads we pride ourselves in legally pushing the envelope in deferring, optimizing and avoiding taxes, but do not support any illegal tax evasion. There is a difference between taking an aggressive position on a gray or ill defined tax area and tax evasion. Whether you might get audited is a fair concern for the former, not for the later.

If you knowingly have excess contributions, you should remove the excess contributions if possible or pay the excise tax until the excess is drawn down. Just FYI, there is no statute of limitations on failure to remove excess contributions.

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Re: How Severe is an HSA Audit?

Post by Hub » Tue Jan 10, 2017 1:40 pm

jebmke wrote:I had an "audit" of my HSA (and Schedule A) one year. They asked for all documents supporting all entries on Form 8889 and Schedule A. It was a letter request, not an in-person audit.
What did you send them? Then what happened?

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Re: How Severe is an HSA Audit?

Post by jebmke » Tue Jan 10, 2017 3:21 pm

Hub wrote:
jebmke wrote:I had an "audit" of my HSA (and Schedule A) one year. They asked for all documents supporting all entries on Form 8889 and Schedule A. It was a letter request, not an in-person audit.
What did you send them? Then what happened?
I sent them copies of forms 5498-SA, 1099-SA and W-2 (code W, Box 12), a spreadsheet reconciling the distributions and copies of the receipts that agreed to the spreadsheet. A few of our providers provide an annual statement (at request). Most pharmacies will produce an annual statement (I get mine from CVS online). The rest, I used the invoice. When I sent it all in, a couple of months or so later I received a letter closing out the audit saying no issues found.

They audited Schedule A at the same time.

I do volunteer work with a retired agent. He said that with reconciliations and reasonable proof (invoices) the agent won't question it unless their is something suspicious on the invoice -- ie., the easier you can make it for the agent the more likely he/she will review it quickly and simply approve the return. Materiality matters. One of my Schedule A items was a 6-figure Claim of Right deduction resulting from weird timing of some ex-pat foreign tax payments that flowed through a prior year W-2. That item took a long time to resolve because the agent who first took the case didn't understand what Claim of Right was and we had to send him a copy of the code section.
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Re: How Severe is an HSA Audit?

Post by mcraepat9 » Tue Jan 10, 2017 3:43 pm

*3!4!/5! wrote:
mcraepat9 wrote:I'm surprised this is a large burden, I just keep a cloud file with scanned receipts and a running tally of how much in HSA-eligible expenses I have incurred. If you do it correctly and contemporaneously the first time, you just need to look at the bottomline number when withdrawing.
One big problem is that with most medical providers it is virtually impossible to attribute a specific payment to a specific service. They will only keep a running tally of what they think you owe and what they think you paid. So any particular payment can never be associated with a particular date of service, and that really opens up a can of worms. At the least, you can keep running tallies of what you owe and what you paid separately for each provider, but you can not separate out the individual instances of service.
This is what I do. It is good enough and should hold up in a HSA audit but we shall see.
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Hub
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Re: How Severe is an HSA Audit?

Post by Hub » Wed Jan 11, 2017 10:24 am

jebmke wrote:
Hub wrote:
jebmke wrote:I had an "audit" of my HSA (and Schedule A) one year. They asked for all documents supporting all entries on Form 8889 and Schedule A. It was a letter request, not an in-person audit.
What did you send them? Then what happened?
I sent them copies of forms 5498-SA, 1099-SA and W-2 (code W, Box 12), a spreadsheet reconciling the distributions and copies of the receipts that agreed to the spreadsheet. A few of our providers provide an annual statement (at request). Most pharmacies will produce an annual statement (I get mine from CVS online). The rest, I used the invoice. When I sent it all in, a couple of months or so later I received a letter closing out the audit saying no issues found.

They audited Schedule A at the same time.

I do volunteer work with a retired agent. He said that with reconciliations and reasonable proof (invoices) the agent won't question it unless their is something suspicious on the invoice -- ie., the easier you can make it for the agent the more likely he/she will review it quickly and simply approve the return. Materiality matters. One of my Schedule A items was a 6-figure Claim of Right deduction resulting from weird timing of some ex-pat foreign tax payments that flowed through a prior year W-2. That item took a long time to resolve because the agent who first took the case didn't understand what Claim of Right was and we had to send him a copy of the code section.
Excellent. Thanks for the insight. I don't have an exact plan on my record keeping yet now 5 years in to maxing my HSA. But I'm young and assume future expenses will eat up what I have so far even if I mess up a bit on keeping track now.

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Re: How Severe is an HSA Audit?

Post by Spirit Rider » Wed Jan 11, 2017 2:04 pm

I keep a spreadsheet with the date of expense, type of expense, date of bill, date of payment, type of payment, date of reimbursement. Sometimes the dates of more than one are the same. It really doesn't take much work at all.

I keep PDFs of the bill (invoice or EOB) and proof of payment. Sometimes everything is contained all-in-one such as a receipt for a prescription or say reading glasses. I keep PDFs of the HSA account statements and Forms 1099-SA and 5498-SA.

Then again, I still have every W-2 I received, dating back to the early 70's.

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Re: How Severe is an HSA Audit?

Post by dodecahedron » Wed Jan 11, 2017 2:28 pm

BolderBoy wrote:I have not had an HSA audit. My understanding is that any monies removed from an HSA account (for any reason) that are not, or have not been, spent on legitimate healthcare needs, are taxed at your marginal tax rate.
In addition to ordinary income taxes at your usual rate, if you are under 65 when you take a distribution for non-healthcare spending, you will owe a 10% 20% penalty.

If you are 65+, you only owe the usual taxes on the distribution, no additional penalty

And of course, under either of the above scenarios, if you did not report all of this correctly at the time you file your tax return, and later catch the error and need to amend, there will be interest and possibly underpayment penalties as well. If the error resulted in a "substantial" underreporting of your true tax liability, there could also be an accuracy related penalty.

Edited to correct--hat tip to pshonore
Last edited by dodecahedron on Wed Jan 11, 2017 4:43 pm, edited 1 time in total.

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Re: How Severe is an HSA Audit?

Post by pshonore » Wed Jan 11, 2017 2:46 pm

dodecahedron wrote:
BolderBoy wrote:I have not had an HSA audit. My understanding is that any monies removed from an HSA account (for any reason) that are not, or have not been, spent on legitimate healthcare needs, are taxed at your marginal tax rate.
In addition to ordinary income taxes at your usual rate, if you are under 65 when you take a distribution for non-healthcare spending, you will owe a 10% penalty.

If you are 65+, you only owe the usual taxes on the distribution, no additional penalty

And of course, under either of the above scenarios, if you did not report all of this correctly at the time you file your tax return, and later catch the error and need to amend, there will be interest and possibly underpayment penalties as well. If the error resulted in a "substantial" underreporting of your true tax liability, there could also be an accuracy related penalty.
I believe the penalty has been increased to 20%

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Re: How Severe is an HSA Audit?

Post by dodecahedron » Wed Jan 11, 2017 4:46 pm

pshonore wrote:
dodecahedron wrote:
BolderBoy wrote:I have not had an HSA audit. My understanding is that any monies removed from an HSA account (for any reason) that are not, or have not been, spent on legitimate healthcare needs, are taxed at your marginal tax rate.
In addition to ordinary income taxes at your usual rate, if you are under 65 when you take a distribution for non-healthcare spending, you will owe a 10% penalty.

If you are 65+, you only owe the usual taxes on the distribution, no additional penalty

And of course, under either of the above scenarios, if you did not report all of this correctly at the time you file your tax return, and later catch the error and need to amend, there will be interest and possibly underpayment penalties as well. If the error resulted in a "substantial" underreporting of your true tax liability, there could also be an accuracy related penalty.
I believe the penalty has been increased to 20%
You are correct. The ACA increased the penalty from 10% to 20%. I have corrected my original entry above and will monitor this in an ongoing way and recorrect again if necessary going forward. (I hadn't paid much attention to that detail, since I am not planning to take distributions until after age 65, and expect to have plenty of health expenses that qualify.)

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