Opus17, thank you for the information. I want to respectively push back here for a minute so please hear me out.
I just looked up Box 3 codes and "1" indicates a normal distribution. Isn't the whole point of identifying the excess back in 2022 addressing the fact that the money should have never been in the HSA in the first place which therefore would mean that it doesn't matter whether or not the funds are used for medical or not. I did pay income tax on the excess and a 6% excise tax penalty for the overage. I continued to pay that 6% excise tax each year the funds are in the account.
The below is directly from the IRS instructions for form 8889. Nowhere under "Distributions From HSA" does it reference a 20% penalty relative to excess funds used for non medical. The IRS knows the funds aren't for medical because they should have never been in the HSA in the first place, hence the excise tax penalty and also why form 1099-SA has a code specifically for excess contributions. I think where we agree is that for 2025, there shouldn't be any excise tax since there is no longer excess (6% x zero = zero). Where I am challenging you is why is this distribution subject to income tax again? The excess was pretax when it went through payroll back in 2022. When i filed my 2022 taxes in 2023, I identified the excess in the HSA and that excess was subject to income tax in the return I filed in 2022. Explain to me why I would pay income tax again on this distribution in 2025? Where is the authoritative guidance that supports your statement on the income tax? I believe I have ruled out the 20% penalty based on review on the IRS form 8889 and the definitions of the distribution codes.
Distributions From an HSA
Distributions from an HSA used exclusively to pay qualified medical expenses of the account beneficiary, spouse, or dependents are excludable from gross income. (See theLine 15 instructions for information on medical expenses of dependents.) You can receive distributions from an HSA even if you are not currently eligible to have contributions made to the HSA. Any part of a distribution not used to pay qualified medical expenses is includible in gross income and is subject to an additional 20% tax unless an exception applies.
