You have entered it correctly.
California uses the same floor as the federal return for medical expenses - medical expenses in excess of 7.5% of your AGI can be deducted.
And as you know an HSA is treated like an ordinary investment account in California. So why it seems to you that you should not be able to deduct HSA distributions because they were tax-advantaged on the federal return, these same distributions were NOT tax advantaged on your previous California returns.
And since the HSA distributions were only for qualified medical expenses, then, yes, they should be added to medical expenses in California.
The timing does present an issue, because you are permitted to pay for medical expenses that happened perhaps years before with your HSA (so long as the expense was incurred after your HSA was created). Because of this, you end up "paying" a medical bill perhaps a year or two or three after you actually did. Yes, you probably paid those bills at the time, and what happened last year was that you reimbursed yourself - but TurboTax has no way of knowing what bills you paid when.
I have not seen any IRS documentation on how to handle this, so I suggest that you let TurboTax do what it is doing. Just keep good notes about what happened in case anyone ever asks (unlikely).
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