"So the HSA custodian has agreed for us to return the mistaken distribution and we should be able to get the funds back into the HSA in the next few days. They said it doesn't matter if it processes after the April 18 tax deadline. We have filed for an extension on our taxes so we will take our time and get it right."
All good.
"My understanding is that we will have to pay the 10 percent penalty on 2023 taxes assuming we don't qualify for the year test."
If your spouse "fails to maintain HDHP coverage" in 2023 (as you expect to happen), then TurboTax will take you through a convoluted calculation to figure out what you should have been able to contribute if you had not used the last month rule. I say "convoluted" because sometimes there is no correction at all.
But you can be sure that there will be a 10% penalty on top of whatever TurboTax calculates. This will appear in Part III of the 8889 on the 2023 return.
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