You are correct and TurboTax is up-to-date on this one. First, be sure in "My Info" you have selected you are former military and retired and resident of AZ. Next, when you enter your military retirement 1099-R the follow on question asks what state you are in (AZ) and where did this distribution come from? About 3/4's down the list is "Retired or Retainer Pay from the Uniformed Services..." Select that box and finish the interview questions. Now when you go back into the AZ interview you will see the $3500 deduction about 5 pages in.
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