"Is that to be expected since the $5,250 excess distribution was done in 2020? " - yes
"I am wondering how the IRS knows I distributed the excess in 2020 before the end of the year." - actually, you did the withdrawal of excess contributions after the end of the year, which is permitted by the IRS. This means that any time they look at the HSA, it is a multi-year view, but the forms don't reflect that.
"But that smart worksheet isn't sent to IRS, correct?" - No, it is not.
Your questions, I think, are rooted in wondering how does the IRS really know what is happening, and the answer is "they don't at this level of reporting."
There are quite a number of things that would not be laid bare unless there was an audit of the taxpayer's return, complete with the examination of several years' worth of returns and records.
For example, how does the IRS know that you were actually covered by an HDHP? They don't, because the return doesn't ask for anything like the insurance company name or group number. They would not discover that you were not properly covered by an HDHP until they do a detailed audit on your return and ask you to produce a variety of records.
My "guess" is that this is because HSAs are relatively new (started in 2004) and in the time since then, Congress has been cutting the IRS' budget so that there hasn't been a form redesign to cover these things or increase the "letter audits" in this area (where an IRS computer detects a funny situation and spits out a letter asking you for clarification).
Our goal, however, is to help you make your 8889 and other parts of your filing as correct as possible so that if audits ever come, that you will not be (negatively) surprised.
**Say "Thanks" by clicking the thumb icon in a post
**Mark the post that answers your question by clicking on "Mark as Best Answer"
