You can't do a return of excess contribution because the deadline for doing so with respect to an HSA contribution for 2016 was October 16, 2017, the extended due date of your 2016 tax return. We are long past that deadline and anything reportable as a distribution from the account treated as an HSA would have to be reported as a regular distribution, code 1. Treating this as an excess HSA contribution corrected by a regular taxable distribution would result in a 6% penalty and inclusion of the amount as income on your 2016 tax return, a 6% penalty for 2017, and, if distributed in 2018, a taxable distribution that is subject to an additional 20% penalty if you are under age 65. If your income falls in, say, the 22% tax bracket, that would be roughly 44% in taxes and penalties on the amount that would be avoided by treating the account as not an HSA as described in IRS Notice 2008-59 Q&A-23.
You mentioned that the HSA custodian is a credit union. I can only assume that either this is a small HSA custodian unfamiliar with this situation or you talked to a front-office person who is ill informed and you need to escalate to the back office personnel who know how to handle this properly.
In the absence of the HSA custodian handling this appropriately, you would have to take it up with the IRS. You would need to convince the IRS that you were (and continue to be) ineligible to open an HSA and that the money that you received back was only taxable, not subject to penalty, and that any Form 1099-SA from the HSA custodian is erroneous.
