When your spouse withdrew the money from her HSA, did she tell the HSA custodian that this was for the "withdrawal of excess contributions"? If not, then the HSA custodian will have their paperwork wrong.
Furthermore, the custodian will send her a 1099-SA with a distribution code of '1' instead of '2'. which means that when the 1099-SA arrives and you enter it into your 2023 return, it will cause you to be penalized.
If this is the situation, you need to have your spouse contact the HSA custodian and ask them to consider this "withdrawal" to be a Mistaken Distribution. If HSA custodian accepts this (be nice, because they don't don't have to), then she will sign a form, and then she will write a check for that amount and send it to them.
Then, do the following:
1. Do enough of your 2022 return in TurboTax to see what TurboTax thinks the excess amount is - we discourage taxpayers from estimating what the excess is because they often get it wrong.
2. As soon as TurboTax determines that there is an excess, TurboTax will add this amount to Other Income if the contributions were through her employer (code W in box 12 on her W-2). You need do nothing else about making this amount taxable.
3. Then contact the HSA custodian and ask for the withdrawal of this amount as "excess contributions".
4. Then in late 2023 or early 2024, the custodian will send her a 1099-SA with a distribution code of '2'. Box 1 will include the amount of the excess plus any amount of earnings made on the excess since they were incorrectly in the HSA. Box 2 will contain the earnings alone. The earnings will be added to your 2023 return.
5. The custodian will send you a check for the amount in box 1.
The "correction" is done on your 2022 and 2023 returns, as described above. Please let TurboTax handle the corrections for you.
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