Since the 2023 excess was not removed in a timely fashion, the 1099-SA should have a distribution code of '1', not '2'. However, it is difficult for HSA custodians to get this right, so if you tell them that this was a distribution for an excess, they take your word for it and put a '2' in the distribution code even when this is not right for a late excess distribution.
Although we normally discourage taxpayers from changing data on forms, you won't be able to get the correct results unless you do.
When you enter the 1099-SA, change the distribution code to '1'. In the interview, be sure to tell TurboTax that this distribution was NOT for qualified medical expenses. This will have three effects:
1. The amount of the distribution will be added to your taxable income.
2. An amount equal to 20% of this distribution will be added to line 17c, Schedule 2 (1040).
3. This will cut off the excess from 2023 so no more penalties.
It is important for you to document what you did and why and save it with the paper copy of your tax return (you keep one, don't you?), in case the IRS ever writes you a letter asking about this.
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