1099-SA Box 3 Codes: Six Codes, Taxes, and the 20% Penalty

Box 3 on Form 1099-SA holds a single digit, 1 through 6, that tells you and the IRS why money left your Health Savings Account, Archer MSA, or Medicare Advantage MSA. The 1099-SA Box 3 distribution codes drive everything that follows on your return: whether the money is tax-free, whether it is ordinary income, and whether a 20% additional tax rides along with it. Six codes exist, and each one lands in a different place on Form 8889.

What Each of the Six Codes Means

Your custodian picks the code based on the circumstances of the withdrawal. You do not choose it, but you do need to understand what the custodian put there before you file.

Code 1: Normal Distribution

This is the default. The custodian uses Code 1 for any withdrawal that does not fit one of the other categories: money you took out for medical bills, money you took out for anything else, and direct payments the custodian sent to a provider on your behalf. It also covers distributions to a surviving spouse after the year the account holder died, because the HSA has become the spouse’s own account by then. A 60-day rollover between HSAs shows up as Code 1 too, since the custodian has no way to know you redeposited the funds.

Code 2: Excess Contributions

If you put in more than the annual limit and withdrew the excess before your tax deadline (including extensions), the custodian uses Code 2. The earnings on the excess are reported separately in Box 2 and are already included in the Box 1 total.

Code 3: Disability

Code 3 covers distributions made after the account holder becomes disabled. The IRS definition is strict: unable to engage in any substantial gainful activity because of a physical or mental impairment expected to result in death or last indefinitely.¹

Code 4: Death Distribution (Other Than Code 6)

Code 4 handles two situations: any distribution paid to any beneficiary during the year the account holder died, and distributions paid to the decedent’s estate after the year of death.

Code 5: Prohibited Transaction

This is the code you do not want to see. Code 5 means the account was used in a way that violates the prohibited-transaction rules, such as pledging the HSA as collateral for a loan or self-dealing with a disqualified person.

Code 6: Death Distribution to a Nonspouse Beneficiary

Code 6 applies when a nonspouse beneficiary (not the estate) receives a distribution after the year the account holder died. The common case is an adult child inheriting a parent’s HSA and receiving the funds the following year.

One boundary worth noting: a direct trustee-to-trustee transfer between HSAs is not reported on Form 1099-SA at all.¹ If you moved your HSA from one custodian to another through a direct transfer, you should not see a 1099-SA for it.

What You Actually Owe Under Each Code

The code sets the ceiling on your tax exposure. What you did with the money sets the floor.

Code 1

Tax-free and penalty-free if every dollar went to qualified medical expenses for you, your spouse, or your dependents. Any portion that went elsewhere is ordinary income and is also hit with a 20% additional tax.² Qualified medical expenses are defined under IRC Section 213(d) and generally exclude health insurance premiums, with narrow exceptions for COBRA, long-term care insurance, coverage while receiving unemployment, and (after age 65) Medicare premiums other than Medigap.

Your custodian does not know what you spent the money on. The burden of proving a Code 1 distribution was qualified sits entirely on you, so keep receipts indefinitely. If a 60-day rollover was coded here, you report it as a rollover on Form 8889 so it is not taxed.

Code 2

The excess contribution itself is not taxed again (it was either never deducted or gets adjusted on your return). The earnings in Box 2 are taxable income for the year the excess contribution was made. The 20% additional tax does not apply when the excess is pulled out on time.

Code 3

Regular income tax still applies to any portion not spent on qualified medical expenses. The 20% additional tax is waived.³ Spend the money on qualified expenses and the distribution is fully tax-free, same as Code 1.

Code 4

The tax outcome depends on who received the money.

Spouse beneficiary: the HSA becomes the spouse’s own HSA. No tax at transfer, and the spouse keeps using it for their own qualified medical expenses. Later distributions to the spouse will appear under Code 1.²
Estate: the fair market value of the HSA is included on the decedent’s final income tax return.
Nonspouse beneficiary in the year of death: the account stops being an HSA, and its fair market value is taxable income to the beneficiary that year, reduced by any of the decedent’s qualified medical expenses the beneficiary pays within one year of the death.

Code 5

A prohibited transaction does not just tax the specific withdrawal. The whole account loses HSA status as of January 1 of the year the prohibited transaction occurred, and the full fair market value on that date is treated as distributed to you. That amount is included in gross income and hit with the 20% additional tax.² This is the worst-case outcome for an HSA.

Code 6

Taxable to the nonspouse beneficiary. The fair market value of the HSA is included in the beneficiary’s income for the year the account holder died, reduced by qualified medical expenses of the decedent that the beneficiary pays within one year of the death.² The split between Code 4 and Code 6 for a nonspouse is purely timing: year of death is Code 4, after that is Code 6.

When the 20% Penalty Goes Away

Three exceptions wipe out the 20% additional tax even when the money was not used for qualified medical expenses: reaching age 65, becoming disabled, and death.² Regular income tax still applies to any non-qualified portion, but the penalty is gone.

After 65, your HSA effectively works like a traditional IRA: tax-free for medical costs, ordinary income for anything else. The custodian will still code these withdrawals as Code 1, because Code 1 is used for all normal distributions regardless of age. You claim the age exception yourself on Form 8889.

Reporting on Form 8889

Filing the 1099-SA alone is not enough. HSA distributions get reported on Form 8889, which attaches to your Form 1040.³ Part II handles the distribution math:

Line 14a: total distributions from Box 1 across all your 1099-SA forms.
Line 15: the portion used for qualified medical expenses. Do not include excess contributions withdrawn after the filing deadline here, even if you spent them on medical bills.
Line 16: Line 14a minus Line 15. This is your taxable amount.
Lines 17a and 17b: if the age 65, disability, or death exception applies, check the box on 17a and calculate the 20% additional tax only on amounts that do not qualify for an exception.

The taxable amount from Line 16 flows to Schedule 1 (Form 1040), Line 8f.⁴ The 20% additional tax on Line 17b goes to Schedule 2.

If Box 3 Shows the Wrong Code

Custodians make mistakes. If the code in Box 3 does not match what actually happened, contact the custodian and ask for a corrected 1099-SA. The IRS instructions direct custodians to correct any filed Form 1099-SA as soon as they discover the error, and the corrected form will have an X in the CORRECTED box at the top.¹

If the custodian will not fix it quickly, you can still file your return according to the actual facts of the distribution rather than the incorrect code. Keep documentation (receipts, death certificate, disability determination) in case the IRS questions the mismatch. Getting the corrected form is still the cleaner path.

Watch one scenario in particular: a timely excess-contribution withdrawal coded as a normal Code 1 instead of Code 2. The two situations run through Form 8889 differently, and the wrong code can leave you overpaying tax on money that was never supposed to be taxed as a regular distribution. Flag it before you file.

Also, if a custodian issued a distribution by mistake and the money was repaid to the account, no 1099-SA should have been issued at all. If you received one for a fully repaid mistaken distribution, ask the custodian to void it.

Two Boundaries Worth Knowing

If your 1099-SA is for a Medicare Advantage MSA rather than a standard HSA, qualified medical expenses are limited to the account holder’s own expenses. You cannot use a Medicare Advantage MSA tax-free for a spouse’s or dependent’s medical costs.⁵ The codes and reporting work the same way otherwise.

California and New Jersey do not recognize HSA tax benefits at the state level. If you live in either state, contributions are treated as state taxable income, investment earnings inside the account are subject to state tax, and a distribution that is federally tax-free for a qualified medical expense may still carry state tax consequences tied to the underlying contributions and earnings.

1
Internal Revenue Service. Instructions for Forms 1099-SA and 5498-SA
2
Internal Revenue Service. Publication 969 (2025), Health Savings Accounts and Other Tax-Favored Health Plans
3
Internal Revenue Service. Instructions for Form 8889 (2025)
4
Internal Revenue Service. Schedule 1 (Form 1040)
5
Office of the Law Revision Counsel. 26 USC 138 – Medicare Advantage MSA