CP2000 Notice: Should I be taxed on HSA distributions for qualified medical expenses?

You're right to question this. When an HSA distribution is used for qualified medical expenses, it shouldn't be taxable. The issue here is likely that while your 1099-SA was reported to the IRS (showing the distribution), you may not have filed Form 8889 with your tax return to show these were qualified medical expenses. The IRS computer system only sees that you received a distribution but doesn't automatically know if it was used for qualified expenses. Without Form 8889 properly completed, the system assumes the entire distribution is taxable. I would recommend responding to the CP2000 by completing Form 8889 for the tax year in question and providing documentation that these were indeed qualified medical expenses. Include copies of your 1099-SA forms showing the distribution code 1, and if possible, receipts for the qualified medical expenses that match the distribution amount.

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Don't forget to keep all your medical receipts for at least 7 years! My cousin got audited 3 years after using his HSA and had to produce every receipt to prove they were qualified expenses. The IRS made him pay taxes plus penalties on the portion he couldn't document with receipts.

Has anyone had success fighting a CP2000 for HSA distributions online through the IRS response portal rather than mailing everything? I'm wondering if I should just use their online system or if it's better to send a physical response with all my documentation.

I dealt with this exact same situation last year! You're absolutely right to question it - HSA distributions for qualified medical expenses shouldn't be taxable. The problem is that the IRS computer system sees your 1099-SA showing the distribution but doesn't automatically know it was for qualified expenses. Even though your 1099-SA has Distribution Code 1, you still need to file Form 8889 with your tax return to officially report to the IRS that these were qualified medical expenses. Without Form 8889, their system assumes the entire distribution is taxable income. For your CP2000 response, I'd recommend: 1. Complete Form 8889 for the tax year showing your qualified medical expenses 2. Include copies of your 1099-SA forms 3. Attach receipts or documentation for the medical expenses that match your distribution amounts 4. Write a cover letter explaining that these were qualified medical expenses Keep copies of everything you send! The IRS should accept your explanation once they see the proper documentation. I went through this process and they completely reversed the proposed tax after reviewing my Form 8889 and supporting documents.