Because your Medicare coverage backdated to January, the IRS considers you to have had $0 eligibility for an HSA the entire year of 2025.
TurboTax’s Form 8889 is likely confused because of the difference between Direct Contributions (your $1,500) and Employer Contributions (the $500).
Your total "Excess Contribution" is $2,000 ($1,500 from your salary + $500 from the company). The $250 in interest is not an "excess contribution," but rather "earnings on excess."
If your W2 shows only $1,500 (your payroll deduction) in Box 12, Code W, and not the $500 company match, your employer likely didn't record their $500 contribution in that specific box.
While selecting "No insurance/Medicare for the whole year" at the very beginning, which is technically true, TurboTax needs to see that you thought you had coverage to process the removal correctly.
Try this specific sequence in the HSA interview:
Did you use your HSA during 2025? Say yes.
Were you covered by a High Deductible Health Plan in 2025? Say yes.
Do any of these situations apply to you? Check the boxes for you had Medicare and that you had other company contributions that weren't reported on your W2.
Did your employer make any other contribution? In the "Contributions not reported in box 12 of your W2", enter $500.
What type of HDHP Coverage did you have: Select you had different plan types at different times of the year.
For each month under Health plans, show select 'Medicare or None'.
Select the type of coverage you had on December 1, 2024.
Your HSA summary should say $2,225 Total Distributions, $250 taxable earnings on excess contributions, and $2,000 of Excess employer contributions withdrawn.
Because you removed the money in the same year you put it in (2025):
- The $2,000 (contributions) and $250 (earnings) should show up as Other Income on your Schedule 1 (Line 8f). This effectively "undoes" the tax-free status they had on your W-2.
- Form 5329 should show $0 penalty. If you see a 6% penalty, the "removal" was not entered correctly.
- Form 8889, Line 14b: Should show the $2,250 total distribution.
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