Short answer: The amount is taxable, and if you’re under age 65, it’s also subject to a 20% penalty, unless you’re able to correct or offset the mistake within the same tax year.
If you use Health Savings Account funds for something that is not a qualified medical expense, the IRS treats the withdrawal as a non-qualified distribution.
The amount must be included in your taxable income. If you are under age 65, an additional 20% penalty generally applies. If you are 65 or older, the penalty does not apply, but the withdrawal is still taxable.
Some HSA providers allow you to correct a mistaken distribution if you catch it quickly. This typically involves returning the funds to the HSA before the tax filing deadline and documenting that the withdrawal was made in error. Availability and procedures vary by HSA administrator.
In addition, some people effectively offset a mistaken withdrawal within the same tax year by paying for an equal amount of qualified medical expenses using non-HSA, after-tax dollars. While the original non-qualified withdrawal remains reportable, having qualified expenses in the same year can help avoid a net tax disadvantage if the HSA funds are otherwise preserved and properly documented.
Because HSA withdrawals are self-reported on your tax return, keeping detailed records of both withdrawals and qualified expenses is critical in case the IRS ever questions the transaction.