Here's how TurboTax handles interest that is not taxable in New Jersey. I am not expressing any opinion about what interest is or is not taxable. The Help in TurboTax also refers you to Bulletin GIT-5.
After you enter a 1099-INT in TurboTax, when you click Continue the next screen says "Tell us if any of these uncommon situations apply." On that screen check the box that says "My state doesn't tax all of this interest." You will then get a drop-down list of states. Select New Jersey and click Continue.
This will exclude the entire 1099-INT box 1 amount from the taxable income on your New Jersey return. (It will be shown as tax-exempt interest on NJ-1040 line 16b.) In spite of the wording on the uncommon situations screen, I don't see any way to tell TurboTax that only part of the interest is not taxable in New Jersey, not even on any of the worksheets in forms mode. If you need to do that, I think the solution is to enter it as two separate 1099-INT forms, one that is taxable in NJ and one that is not. I don't think that splitting the 1099-INT will cause any problems.
