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California taxable income: should HSA contributions be added back or not?

ELAINE

Hi, when preparing my California state tax in FreeTaxUSA, I noticed that the software is treating my HSA contributions as "California Additions to Income", hence it increased my California taxable income. However, I looked up on the California Franchise Tax Board website, and it looks like a bill was passed in 2022 to exclude HSA contributions from California taxable income. Is my understanding correct? Please see link to the bill below:

https://www.ftb.ca.gov/tax-pros/law/legislation/2021-2022/AB727-010322.pdf

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Comments

KeriC

Thanks for asking. The bill that you linked to was a proposed bill, but the bill did not pass. It is correct to have your HSA contributions added to your CA taxable income since the state does not conform to the IRS' treatment of the contributions as pre-tax.

llamafilm

I noticed this too, and I think there's a bug with the calculation on this website. My employer subtracts HSA contributions automatically on the W2 state income (so box 16 is less than box 1 by that amount). This website fails to consider that. Instead, it appears to use the federal AGI and adds the HSA contribution to that. When I filed for free using the CalFile state website, my refund was about $400 higher than FreeTaxUSA's calculation.

llamafilm

I wrote that backwards. I meant to say, box 16 is $4300 higher than box 1.

MatthewD

Hi llamafilm,

I understand the confusion here — this is actually a common point of misunderstanding, and it's a fair question to raise.

Your employer is correct to report a higher amount in box 16 than box 1. Since California doesn't recognize HSAs, your employer added the HSA contribution back into your CA state wages on the W-2. However, the way California calculates your state taxable income is not based on box 16 at all.

Here's how it works: California starts with your federal Adjusted Gross Income (AGI) and then makes additions or subtractions for differences between federal and CA law. Since your federal AGI already excludes your HSA contributions (they were pre-tax at the federal level), California requires those contributions to be added back in as a CA addition to income. This is what you're seeing in our software, and it's the correct treatment per FTB instructions.

Box 16 from your W-2 does appear on line 12 of your CA Form 540, but that line is not used to calculate your CA taxable income. The actual CA AGI is calculated on lines 13–19 of the return. So there is no double-counting — the software is only adding the HSA contribution back once, starting from your federal AGI.

As for the difference you saw with CalFile, it's possible that CalFile used box 16 as a starting point rather than federal AGI, which would produce a different (and likely incorrect) result. The FTB's own instructions confirm that CA AGI is derived from federal AGI with adjustments, not from the W-2 state wages box.

You can verify this by previewing your CA return in the Final Steps menu and reviewing lines 13–19 of your CA 540.

gta2000

As of 2025, CalFile doesn't support HSA income source, you cannot use CalFile for reporting CA tax if you have employer HSA contribution.

FTB 2025 instruction saying:

Employer health savings account (HSA) contribution

– Enter the amount of any employer HSA contribution from federal Form W-2, Wage and Tax Statement, box 12, code W on line 1h, column C.

While in CalFile saying:

To use CalFile, you must have at least one type of taxable income listed below. If you received types of income not listed, you cannot use CalFile.

Wages, tips, scholarships (W-2)
Interest (1099-INT)
Dividends (1099-DIV)
Gambling (W-2G)
IRA, Pension, or Annuity reported on Form 1099-R
Railroad Retirement reported on Form RRB-1099-R
1099-MISC with no state tax withholding (box 15)
Alimony paid or received if divorce/separation agreement occurred before January 1, 2019
Scholarships or grants included as income on your federal return but were not reported on Form W-2
Self-Employed income for California Earned Income Tax Credit (EITC) only

Tried selecting all different type of income could not add the HSA amount into line 1h, column C.
That's why it says "If you received types of income not listed, you cannot use CalFile."

So, don't use CalFile if you have HSA contribution from your employer.