My understanding is in 2024 tax return I should only report $X excess contribution withdrawn.
TurboTax will report that you have withdrawn the $X, if you answer the excess contribution screen with "you will withdraw the full amount" which is $X in this case.
In 2025 tax return I need to report $Y-X as distributions(with medical expenses), is that correct? But I guess I will receive 1099-SA with $Y and distribution code=2, right? Will that be an issue?
If you can collect and document in 2025 medical expenses that are not reimbursed by your HSA or insurance, then you can do what I described above. But to make this work in TurboTax, you will need to
1. alter the data on the 1099-SA
2. Create a pseudo 1099-SA to describe the distribution of the amount of $Y less $X.
To do #1, change the box 1 amount (the distribution) to be only as much as TurboTax tells you the excess actually is. Leave the earnings alone because they were sent to you so you should pay tax on all of them.
To do #2, enter an new 1099-SA whose box 1 amount is the difference between $Y and $X, whose box 2 amount is zero, and whose box three amount is "1". In the interview after you enter it, the answer to the "did you use this for medical expenses?" depends on how many medical expenses you have been able to document by the time that you do your next return as being covered by this amount.
As I noted elsewhere, since you are altering documents copied to the IRS to try to come to an equitable situation, please document everything you are doing and why. We are not able to point to specific examples by the IRS for this situation, so any defense would be that you tried the best you could to rectify the situation. Then bring this documentation out if anyone ever asks any questions.
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