@xiaochong2dai
The contributions were withdrawn pre-tax, and will be reported on your wife's W-2s. Your tax software (Turbotax or whatever else you use) will see that, and will ask if she had qualifying insurance. When you answer "no" (because even though she had a qualifying plan, she is disqualified by your HSA), those contributions will be added back to her taxable income. That will increase the tax you owe or decrease your refund when you file your return. Therefore, the excess is not also taxed when it is withdrawn. The only part of the withdrawal that is taxed is the interest she earned (if the account paid interest).
