Thank you for the reply.
He is over the age limit where they impose the 20% penalty tax so we don't have that issue thankfully.
I believe code 2 is correct since it is for “excess contributions” made in 2023, which is when he overfunded his HSA due to retiring that year. Although it is too late for a "corrective" distribution, I believe he still had excess contributions in the account until we received the check on April 8, 2025.
I did try to use code 1 and call this a normal distribution, not for medical expenses, but it still presents incorrectly. It adds the $2829 to our taxable income, so we will be paying tax again on this $2829 when we already paid the tax on the $2829 in 2023.
My thought is to leave it as a code 2 "excess contribution" as shown on the 1099-SA, and since the $2829 and the ($1) earnings were withdrawn by the due date of the 2024 return, in the interview I will not check the box that he overfunded his HSA last year (2024) and put $0.00 for the excess contribution question. When I do this the $170 penalty disappears, and we are only taxed on the $1.00 gain earned on the $2829. Also, Form 5329 line 48 is blank so the excess contribution is not carrying over to 2026. (We did pay the $170 penalty both in 2023 and 2024.) So far this seems to be the most correct way to enter the information.
Thank you for the reminder to I keep records in case I have to explain things to the IRS. I will keep a copy of the cancelled check from the HSA administrator (deposited before the due date of the 2024 return), and they should be able to verify that we paid taxes on the $2829 on our 2023 return (copy saved in our records as well). Again, it is my understanding that at this point we should not have to pay income tax again on the $2829 -- we only owe taxes on the earnings in the year (2025) we received the distribution of the excess contribution plus earnings.
