Using code 2 instead of code 1 for a distribution that is required to be treated the same as a distribution reported with code 1 makes no sense. Although the instructions form Form 1099-SA aren't entirely clear on this, it only makes sense to use code 2 for a return of excess contribution before the due date of the tax return, which is not possible for the $475.01 distribution. If reported with code 2, TurboTax (and the probably the IRS as well) will treat it as nontaxable. However, to eliminate the excess $475.01 from the HSA the distribution is required to be taxed and, if you are under age 65, be subject to a 20% penalty. To resolve this excess, the $475.01 must appear on Form 5329 line 44 which is required to come from Form 8889 line 16, which will only happen if the Form 1099-SA has code 1.
