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Get your taxes done using TurboTax
"If I select "NO" as you've indicated regarding withdrawing excess contributions, won't this result in the 6% penalty?"
Yes, but as I pointed out above, the carryover penalty is 6% of the SMALLER of the carryover or the amount in the HSA at the end of the year, Since the amount in her HSA at the end of the year (I assume) was zero, 6% of zero is zero...so no penalty.
"Is it correct that she is being 'penalized' in this way because of the timing of the contribution and I should just leave all inputs in TT as they are?"
The effect of the last-month rule is to allow you the full annual HSA contribution limit, no matter how few months you had the HDHP insurance. So her employer could have contributed $500 (as it did) or $1,000 or the maximum of $3,600, all in December.
The "only" problem with the last-month rule is that you (well, your daughter) has to stay under HDHP coverage for the next year. If she does not (as she did not), then TurboTax has to ask you a lot of questions (which I guess you have seen) to recalculate what the annual HSA limit would have been if there were no last-month rule, and then use that to figure the amount of the excess HSA contribution.
In this case, she would have been allowed for one month an annual HSA contribution of $300 (1/12 times $3,600), so the $500 contribution would have been a $300 HSA contribution and a $200 excess contribution (which, yes, you add to income and pay tax on).
So, because I am not sure what you have entered, I would say, leave everything as it is but make sure that you don't tell TurboTax that you will withdraw the excess contribution for 2022 by April 18th, because you can't withdraw money that isn't there.
So, yes, she will pay tax for "failure to maintain HDHP coverage" - see line 18 on form 8889, but she should not pay a penalty for the carryover of the excess to 2023 - see line 49 on form 5329.
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