While we are not qualified to comment on the consequences of correcting your IRS filings, we believe that you should correct any inaccurate information reported to the IRS. IRS Notice 2008-59 states that the sanction for a prohibited transaction (such as borrowing from or lending to the HSA) is disqualification of the account as an HSA. “Thus, the HSA stops being an HSA as of the first day of the taxable year of the prohibited transaction (Q&A 37). The assets of the beneficiary’s account are deemed distributed, and the appropriate taxes, including the 10 percent [now 20 percent] additional tax under § 223(f)(4) for distributions not used for qualified medical expenses, apply.” Id.Internal Revenue Code Section 223(f)(4)(A).
Therefore, once the customer made the prohibited transfer out of the HSA, the account ceased to be an HSA. Any transfers back into an account after a prohibited transaction should not be reported as HSA contributions or rollovers. To the extent that your IRS reporting does not reflect that a prohibited transaction occurred, it should be corrected.