The 20% penalty
The IRS imposes a 20% penalty on any distribution for a non-qualified medical expense, on top of ordinary income tax.
"You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax."
Source: IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans
What an IRS audit checks for
The distribution was used to pay for or reimburse a qualified expense
You didn't get reimbursed for that same expense from somewhere else
The expense wasn't part of an itemized deduction on any tax return
Penalties by age
If you withdraw HSA funds for a non-qualified expense:
Under 65: you'll owe ordinary income tax and a 20% penalty on the amount withdrawn
65 or older, or disabled: you'll owe ordinary income tax only. No 20% penalty applies
Qualified expenses without receipts
The 20% penalty applies to non-qualified expenses. But if you can't produce a receipt for something that actually was qualified, you may still be at risk in an audit if you're unable to substantiate it.
Ways to avoid the penalty
Keep a receipt for every qualified medical expense.
If you've already spent funds on something unqualified, you can recategorize the transaction and redeposit the funds.
If you're 65 or older, or disabled, you won't owe the 20% penalty on a non-qualified withdrawal, though you'll still owe ordinary income tax on it.