1) Yes. Only the $3,850 needs to be made taxable to eliminate the $3,850 of excess.
2) Because the distribution occurred in December 2024, the distribution goes on your 2024 tax return and eliminates the excess on your 2024 Form 5329 such that no excess carries over to 2025. Nothing about this excess will appear on your 2025 tax return.
"I don't understand the logic of timely-withdrawn excess contributions being taxed while the earnings on that excess are not. Seems like a loophole for untaxed gains (especially on the 2024 earnings on excess)."
Yes, that is a bit of a loophole. It's necessary to treat it this way to make the result equivalent to the case where someone can, explicitly permitted by the tax code, instead apply the excess as a future-year contribution and not need to remove the excess or gains.
