What happens to your taxes when you close an FSA or HSA

Closing an FSA or HSA triggers different tax consequences depending on which account you have and why you are closing it. An FSA (Flexible Spending Account) has strict use-it-or-lose-it rules: money you do not spend by the end of the plan year or grace period is forfeited to your employer, and you receive no tax refund. An HSA (Health Savings Account) works differently — you own the money, it rolls over year to year, and you can withdraw it anytime, though non-medical withdrawals before age 65 trigger income tax plus a 20 percent penalty.

The tax hit depends on what you do with the money. If you close an FSA, you simply lose unspent funds; there is no tax bill because you never claimed them as income. If you close an HSA and withdraw money for non-medical reasons, you owe income tax on the full amount withdrawn plus the penalty. If you close an HSA and leave the money untouched, or withdraw it only for may have access to medical expenses, there is no additional tax.

Key Takeaways

  • FSA money you do not spend by the end of the plan year or grace period is forfeited with no tax refund; this is not a tax event, just a loss of the funds.
  • HSA withdrawals for non-medical reasons before age 65 are taxed as ordinary income plus a 20 percent federal penalty, which appears on your tax return.
  • HSA withdrawals for may have access to medical expenses are never taxed, even if you close the account, as long as you keep receipts proving the expense was medical.
  • If you close an HSA and do not withdraw the money, you owe no tax; the account simply closes and the balance remains yours to withdraw later if needed.
  • State taxes may apply to HSA non-medical withdrawals in some states, adding to your federal tax bill.

How FSA forfeiture works and why there is no tax refund

When you close an FSA or leave your job mid-year, any money still in the account is forfeited to your employer. This is not a taxable event — you do not owe income tax on the forfeited amount because you never actually received it as income. The money was deducted from your paycheck before taxes, and once it is forfeited, it stays with your employer or is used to offset plan administration costs.

The only exception is if your employer allows a grace period, usually 2.5 months after the plan year ends. During this time, you can still spend down your FSA balance on may have access to medical expenses. If you close the account before using the grace period, those funds are lost. There is no way to recover forfeited FSA money through a tax deduction or refund.

HSA withdrawals for non-medical reasons and the 20 percent penalty

If you close an HSA and withdraw money for anything other than a may have access to medical expense, you owe federal income tax on the withdrawal amount plus a 20 percent penalty. The penalty is separate from income tax — it is an additional cost imposed by the IRS for misusing HSA funds. Both the income tax and penalty are reported on your tax return for the year you make the withdrawal.

For example, if you withdraw $5,000 from your HSA for a non-medical reason, you owe income tax on that $5,000 at your ordinary tax rate (which could be 12 percent, 22 percent, or higher depending on your income), plus $1,000 in penalties. If you are in the 22 percent tax bracket, your total tax bill would be $2,100 ($1,100 in income tax plus $1,000 in penalty). This amount is due when you file your tax return.

The 20 percent penalty does not apply after age 65. Once you turn 65, you can withdraw HSA money for any reason and owe only income tax, not the penalty. This makes HSA funds essentially equivalent to a traditional IRA after age 65.

HSA withdrawals for medical expenses and tax-free treatment

HSA withdrawals for may have access to medical expenses are never taxed, even if you close the account. may have access to expenses include doctor visits, prescription medications, dental work, vision care, mental health treatment, and many other health-related costs. You do not need to withdraw the money in the same year you incur the expense — you can pay for medical care out of pocket and reimburse yourself from your HSA years later, as long as you have documentation.

To avoid tax problems, keep receipts and invoices for all medical expenses you plan to reimburse yourself for. The IRS does not require you to submit these documents when you file your tax return, but you must have them available if the IRS audits you. If you cannot prove an expense was medical, the IRS will treat the withdrawal as non-medical and assess income tax plus the 20 percent penalty retroactively.

When you close an HSA, you can withdraw money for past medical expenses without triggering tax or penalties. There is no time limit on how far back the expenses can be, as long as they occurred after you opened the HSA and were not already reimbursed by insurance or another source.

What happens if you close an HSA and do not withdraw the money

If you close an HSA and leave the balance in place without withdrawing it, you owe no tax. The money remains yours indefinitely. You can withdraw it later for medical expenses or, after age 65, for any reason. Some people close their HSA accounts with their employer but keep the account open with the HSA custodian (the bank or financial institution that holds the money), allowing the balance to sit and grow tax-free.

This strategy is common for people who have other sources of funds to pay for medical expenses and want to let their HSA grow as a long-term investment. The HSA can function like a retirement account, with the added benefit that withdrawals for medical expenses are always tax-free, even in retirement.

State taxes and HSA non-medical withdrawals

In addition to federal income tax and the 20 percent penalty, some states impose their own income tax on HSA non-medical withdrawals. The state tax rate varies — it could be 3 percent, 5 percent, 8 percent, or higher depending on where you live and your income level. A few states do not have income tax and therefore do not tax HSA withdrawals.

To find out whether your state taxes HSA withdrawals, contact your state tax authority or review your state's HSA rules. If you live in a high-tax state and are considering a non-medical HSA withdrawal, the combined federal and state tax bill could be substantial — potentially 30 to 40 percent or more of the amount withdrawn.

Reporting HSA transactions on your tax return

HSA contributions, withdrawals, and earnings are reported on IRS Form 8889, which you file with your tax return. If you made non-medical withdrawals, the form shows the withdrawal amount, the portion that is taxable, and the 20 percent penalty. Your HSA custodian sends you a Form 1099-SA each January showing all withdrawals from the previous year, which you use to complete Form 8889.

If you close an HSA mid-year, make sure your custodian reports the closure correctly on your Form 1099-SA. If there are errors, contact the custodian and ask for a corrected form. Mistakes on HSA reporting can trigger IRS notices or audits, so it is important to reconcile your records with the forms you receive.

Frequently Asked Questions

Can I get my forfeited FSA money back at tax time?

No. Forfeited FSA money is not refunded and cannot be claimed as a deduction on your tax return. Once the plan year ends and you do not spend the money, it is gone. The only way to recover it is to spend it during the grace period if your employer offers one.

Do I owe taxes if I close my HSA and do not touch the money?

No. If you leave the balance in your HSA and do not withdraw it, you owe no tax. The money remains yours and can be withdrawn later for medical expenses or, after age 65, for any reason without penalty.

What counts as a may have access to medical expense for HSA withdrawals?

may have access to expenses include doctor and dentist visits, prescription drugs, vision care, mental health treatment, medical equipment, and many other health-related costs. Over-the-counter medications count only if you have a prescription. Cosmetic procedures, gym memberships, and general wellness products do not count. The IRS publishes a full list on its website.

If I turn 65, can I withdraw HSA money for anything without penalty?

Yes. After age 65, you can withdraw HSA money for any reason and owe only income tax, not the 20 percent penalty. This makes the HSA function like a traditional IRA in retirement, though withdrawals for medical expenses remain tax-free at any age.

What if I made a non-medical HSA withdrawal by mistake?

You still owe income tax and the 20 percent penalty on the withdrawal. The IRS does not waive the penalty for mistakes. Your only option is to report it correctly on your tax return and pay the tax and penalty due. Some people attempt to redeposit the money, but this is complex and requires IRS approval in certain circumstances.