It appears the online version of TurboTax is treating my HSA distribution as income even though the funds were used for qualified med. expenses. How do I fix this?

[BMcCalpin]

When you entered the 1099-SA (distributions), the tax due is immediately increased because - for the moment - the distributions are considered taxable. However, when you indicate that the distributions were all for qualified medical expenses, the tax due should have decreased, since the distributions are no longer considered taxable.

What you may be seeing is not the distributions, but the contributions. 

When you enter the W-2, if there is an entry in box 12 with a code of W (HSA contributions from your employer and you through payroll deduction), this amount is added to your taxable income. Why? Because it is considered taxable until your form 8889 is completed. Form 8889 is completed when you complete the HSA interview at Federal->Deductions & Credits->Medical->HSA, KSA Contributions.

During the HSA interview, when you indicate that you are covered by an HDHP, then the code W amount will be removed from your taxable income. Note that this is after you enter the 1099-SA. That is, your taxable income may seem too high because of the contributions, not the distributions.

Having said all that, as you suspect, the distributions should not be taxable, once you indicated that they were all for qualified medical expenses. 

Be sure to go all the way through the HSA interview, because there are questions all the way to the end that affect your HSA.

If completing the interview doesn't help, there may be some spurious data that is confusing TurboTax.

As a last resort, try doing the following:

1. make a copy of your W-2(s) (if you don't have the paper copies)

2. delete your W-2(s) (use the garbage can icon next to the W-2(s) on the Income screen

*** Desktop***

3. go to View (at the top), choose Forms, and select the desired form. Note the Delete Form button at the bottom of the screen.

*** Online ***

3. go to Tax Tools (on the left), and navigate to Tools->Delete a form

4. delete form(s) 1099-SA (if one), 8889-T, and 8889-S (if one)

5. go back and re-add your W-2(s), preferably adding them manually

6. go back and redo the entire HSA interview.