HSA Distribution - odd scenario

[jnkniffencpa]

I have an odd scenario where a client contributed to their HSA based on the last-month rule. They did not remain eligible for the entire testing period and were forced to take the ineligible amount into income and pay the penalty. Since there is no requirement to remove that additional amount  they have a balance in their HSA that they have now paid taxes on.

So, if they remove this money from the account but don't use it for medical expenses, how do you keep them from paying taxes on it again?

Thank you in advance for your input!

Jeremy

[Terry53029]

If you fail to remain an eligible individual during any of the testing periods, the amount you have to include in income isn’t an excess contribution. If you withdraw any of those amounts, the amount is treated the same as any other distribution. See Pub 969