@Samosa The tax would only be upon withdrawal from the fund. You are a cash basis taxpayer and do not have use of those funds till they are used for medical expenses or you take them out where they would be a 1099 for other purposes. The principal portion is tax free used for medical expenses and you can utilize any fair allocation approach for the earnings as none has been specified. Example if your basis is $100 and at withdrawal you had $250 of gains/interest/dividends. Total value $350. Let' say you had medical expenses of $50 that year and that is what you withdraw which for fed is non-taxable. For state though the cost basis is non-taxable and the rest is includable in income. You could choose to say all is non taxable till you hit your $100 basis or prorate the portion of income. $50 X 250/350= earnings portion and even that portion may be deductible as medical expenses if you qualify (the cost basis would not be).
So possibly, you would have no income to report. California on the other hand has opined.
Do not take this as tax advice. There is NO approved nor has NJ attempted yet to require 1099's on this income and they so far have given no written decision on how to report.
It is an interesting decision and since there is no advice given, it is fair to take this approach.
The dividends reportable should be reported as Other Non-Wage income. After you complete the NJ return, go to adjustments, Other Non-Wage Income.
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