Yes, an HSA Funding Distribution is not taxable, but you also do not get a deduction for the HSA contribution. A taxable distribution that is not subject to an early-distribution penalty offset by the deduction for a regular HSA contribution produces the same taxable result without any of the negatives of an HFD. This is why in during entry of the code 4 Form 1099-R for a distribution from an inherited IRA TurboTax never asks whether the distribution was put in an HSA.
Regarding an example, a distribution of $3,500 from an inherited IRA adds $3,500 to AGI while a deduction for a regular $3,500 contribution to an HSA made with that $3,500 subtracts $3,500 from AGI, for a net change in AGI of zero. An HFD results in $0 added to AGI and $0 deduction, for the same zero net change in AGI, but comes with all of the negatives of an HFD, particularly that the HFD becomes taxable and subject to a 10% penalty if the individual fails to be an HSA-eligible individual for any of the 12 months following the month of the HFD, hundreds of dollars on a $3,500 HFD. If one simply obtains an IRA distribution that is not subject to penalty and makes a deductible HSA contribution for the same net change in AGI of zero, there are no consequences to failing to remain an eligible individual (other than any potential consequences under the last-month rule which would be less severe than the consequences with respect to an HFD).
