"1. Are you stating that even though we withdrew the 2016 excess contributions from our HSA that withdraw was for nothing because it was past the 2017 due date, meaning that we withdrew all that money from our HSA and we can't even declare it?"
Yes. The excess must be withdrawn by the due date of the return, or else a different process has to be applied to handle it.
"2. If the withdraw was for nothing is there a way to put that money back in the HSA since it was withdrew for no reason?"
At this point, it is too late. You needed to fix that in 2018.
"3. Should the 1099-SA withdraw been coded differently (meaning as a normal distribution) by the HSA custodian so that we could declare it was removed?"
It sounds to me that the HSA custodian made a mistake, in that they let you try to withdraw the 2016 excess in 2018 and filed the paperwork that way (a 1099-SA with a distribution code of '2'). If so, they fouled up. But, unfortunately, it is long past time to fix this.
"4. Something does not seem right that you have to lie about actual medical expenses to remove the excess contributions with a 20% penalty as the only way to remove the excess contributions from being carried over every year. Is there another way to remove the excess contributions?"
The "lie" is only a way to get TurboTax to do what you want. Remember that lying to TurboTax is not like lying to the IRS. Besides, your HSA custodian apparently violated the HSA reporting rules, and you can't expect TurboTax to have coded its software to handle that.
I gave you this as option if you had a 1099-SA for 2019 (with a distribution code of '1'). If you don't, then you'll have to request a distribution now for that excess amount, and do it in 2020.
You asked me how to cut off the excess carryover - this is how you do it in TurboTax to conform with the IRS rules.
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