This is a lengthy answer, because what you describe could be caused by several things...
As you know, the HSA distribution as reported on form 1099-SA is not taxable IF the entire amount was used for qualified medical expenses.
There are some issues here.
First, when you enter the distribution in the 1099-SA part of the HSA interview, the distribution will initially be shown as taxable. This is because the IRS considers the distribution to be taxable by default, until the taxpayer shows that the distribution was for qualified medical expenses.
So at this point, the distribution shows up on form 8889 and also on line 21 Other Income on Schedule 1 (Form 1040).
The screen after you enter the distribution, you are asked if the distribution was for qualified medical expenses. However, the tax return is not updated immediately, but not until you hit Continue to get the next screen after that. Then, once you have hit Continue after telling TurboTax that the distribution was all for qualified medical expenses, the distribution will be removed from Other Income and form 8889 will be updated. Certainly, any time after this, you should be able to go to Schedule 1 on the 1040 and see that the distribution is not there, showing that it is not taxable.
This is why we encourage taxpayers not to watch the Refund Meter too closely, because TurboTax may have to do some things in the background out of sync with what you see on the screen.
However, there are two ways in which you might think that you are being taxed anyway.
The first is that on the Wages & Income screen, the distribution will appear at the top as an apparent income item. It's not. It is printed here because it might be an income item, but it isn't once you tell TurboTax that it was all for qualified medical expenses. Line 21 is the real test; please check it.
Second, as noted above, the IRS believes that, by default, that HSA distributions are taxable until you declare that they were all for qualified medical expenses. Thus as soon as you hit continue on the screens where you enter the 1099-SA, your refund is reduced (or your tax due increased) because it is temporarily considered taxable.
However, the next screen asks if this distribution was all for qualified medical expenses, and when you check "yes" and then hit Continue, then on the next screen the distribution is removed from Other Income and your refund should go back to normal.
Note that this second recalculation doesn't always take place immediately (depending on how busy your return is and how busy your computer is), and it's important that you not jump away from this screen too quickly, because that can freeze the distribution in Other Income. This is one reason why we recommend that taxpayers always go all the way to the end of the HSA interview before leaving for another section - to make sure that all the calculations that need to be done are in fact done.
If you have gotten to the end of the HSA interview and have entered that the distributions are all for qualified medical expenses, but the distributions are still on line 21 (Other Income), then you should delete all your HSA information and start over. To do this, please do the following:
The safest - although brute force - way to fix this is to do the following in this order:
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.
