OK, so you entered the refund (good).
"I can only see the refund showing up in a Federal Carryover Worksheet"
I am not sure what this is referring to, and it's not germane anyway. For which year are you looking at the Federal Carryover Worksheet?
What is germane is the Federal Carryover Worksheet for 2019, because it should have the value for your Itemized Deductions in 2018. Of course, if the refund was from a year prior to 2018, then TurboTax would be dependent on your input, unless it was smart enough to look at your Tax History (another worksheet) where itemized deductions for the last 5 years are shown. (I don't know if TurboTax does this or not - in any case, I am pretty sure that you are invited to enter the amount when entering the 1099-G).
So if TurboTax calculated zero for the taxable amount of the refund, then it seems that what TurboTax had for itemized deductions (whether through the Carryover Worksheet or the Tax History worksheet or through your own data entry) was not the same as what the IRS has.
So go look at the IRS letter and see if it described how they arrived at the conclusion that some of the refund was taxable. Then go compare what the IRS says (the itemized deduction amount is the most likely problem) with what was on your tax return for the year that the refund came from (2018? earlier?).
If you show a different number, then make a photocopy of the relevant pages on your return, write out the calculation that Jokita and Dawn described, and send the response back to the IRS. They will always give you at least one chance to explain why their adjustment is wrong (but always reply on time!).
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