The HSA administrator should not have allowed you to withdraw the $860 in 2022 as an excess contribution, because at that point, it was already too late to withdraw the excess from tax year 2021 (unless, by some miracle, you filed for an extension for tax year 2021 - did you?).
But HSA custodians are notoriously resistant to fixing their own mistakes, especially after the tax year is finished.
Contact your HSA custodian and ask that the withdrawal of the $860 be recharacterized as a normal distribution, because they should never have accepted your request in the first place since it was after the due date.
They will almost certainly refuse. If so, just document the date and time and what you said and what they replied.
Enter your 1099-SA for the $860 in 2022 as if it were a normal distribution, but one which you did not apply to qualified medical expenses. This will not sync with what your HSA custodian has on their books, but that is why you are going to document their error.
The 1099-SA for the $860 was issued in 2022 after April, right? If so, it belongs on your 2022 return, which you are doing right now. You removed the $860 (good), and when you state that this was not for qualified medical expenses, the $860 will be added to Other Income (good). You will be fined 20% (not good, but necessary), and the carryover of the $860 will be terminated.
At the end, you will have paid 6% just once, and you will use the existing $860 withdrawal to cut off the carryover, and not have to withdraw a new $860.
This carries some risk, in that your tax return(s) will not longer match the HSA custodian's books. But (1), you can point out that their books are in error, (2) they declined to fix their books, and (3) you ended up doing the right thing anyway, while not avoiding any income tax or penalties other than what you truly owed.
If you choose this path, make sure to document everything, in case anyone ever asks.
P.S., I am ignoring the earnings on the $860. This is because the earnings are reported only when you withdraw excess contributions. But we are recharacterizing what you did as not a withdrawal of excess earnings. Therefore the earnings would not have been reported to you. Is that sneaky? No, because you are accepting a 20% penalty in lieu of the earnings. The IRS comes out ahead in this case, and you are finished with the whole affair.
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