Problem solved! The trick is that you do not click "we need to adjust the taxable amount" box. The program already automatically adjusts the interest by subtracting the bond premium in box 13 from the interest in box 8. Good thing I did not try to ignore the error message. When looked at the forms, the amount for tax exempt interest on both the federal return and state return were wrong. I went back and deleted the respective 1099 INT forms and started over, one by one, checking what happened in the forms as I went. I discovered that by not checking the "we need to adjust the taxable amount" and not entering a taxable amount adjustment, I got the correct numbers on the forms.
