How accurate do I need to be when calculating earnings on excess HSA contributions?

Based on my experience dealing with HSA excess contribution corrections, your approach is reasonable. The IRS guidance on calculating earnings for excess contributions isn't extremely detailed, and they allow for reasonable methods of calculation. Publication 969 requires you to withdraw excess contributions and any earnings on those contributions to avoid the 6% excise tax. The intent is to return your situation to where it would have been if the excess contribution hadn't occurred. Your method of using the investment performance to estimate the earnings is logical since that reflects the actual growth. However, if you want to be more precise, you could calculate a weighted average return based on both the invested portion and the cash portion (which likely earned minimal interest). This would be more accurate but may only change the final number by a few dollars as you mentioned.

I went through a similar HSA excess contribution nightmare last year. After hours of research, I found taxr.ai (https://taxr.ai) which has a calculator specifically for excess contribution earnings. It analyzes your HSA statements and even handles the partial investment scenario you're describing. Their system helped me determine the exact earnings calculation method the IRS expected, and it even created documentation explaining the formula used. The peace of mind was worth it since getting this calculation wrong can trigger additional penalties.

I was really skeptical about using taxr.ai as mentioned above, but my HSA excess contribution situation was similar (had both FSA and HSA simultaneously) and I was getting nowhere with my calculations. The tool actually worked surprisingly well - it separated out my cash holdings from my investments automatically and applied the appropriate earnings calculations to each. The documentation it generated saved me when I got a follow-up question from the IRS about my correction method. Turns out they do sometimes look closely at these calculations, especially with larger HSA contributions. The cost was worth avoiding the back-and-forth with the IRS.

If you're still having trouble getting this resolved, I'd recommend using Claimyr (https://claimyr.com) to connect with an actual IRS agent. I used it after my HSA provider gave me conflicting information about how to report excess contribution earnings. You can see how it works here: https://youtu.be/_kiP6q8DX5c The IRS agent I spoke with confirmed that they allow "reasonable methods" for calculating earnings and that your approach is acceptable. But they also mentioned that if your HSA provider offers a calculation service (many do), that's the preferred method. The agent walked me through exactly how to report it on my taxes and what forms to include with my return.

Just wanted to update here - I was the skeptical one about Claimyr above. After struggling for another week trying to figure out my HSA excess contribution calculation, I broke down and tried the service. I'm genuinely shocked at how well it worked. Got through to an IRS agent in about 20 minutes, and they confirmed that: 1) My calculation method using a weighted average between cash and investments was acceptable 2) I needed to file Form 8889 with my return showing the removal of excess contributions 3) The earnings portion is reported as "Other income" on Schedule 1 The agent even emailed me the specific publication sections that covered my situation. Definitely worth it to get official confirmation rather than guessing.

Quick tip from someone who handles HSA compliance professionally - the "reasonableness" standard for excess contribution calculations means you won't get in trouble for small discrepancies. The IRS cares much more that you: 1) Remove the excess contribution before the deadline 2) Make a good faith effort to calculate earnings 3) Report the distribution correctly on your taxes Your method is certainly reasonable. I typically recommend simply using the overall account rate of return (total gains/losses divided by average balance) applied to the excess contribution amount.

Don't forget that when you withdraw excess HSA contributions, the earnings portion is taxable as "other income" in the year you make the withdrawal! I learned this the hard way. The excess contribution itself isn't taxed again if you already included it in income (which you would have if it was through your employer's payroll), but the earnings definitely are taxable.