"That retirement account from which distributions were made is exempt because it is under the heading of "distributions from plan to which you cannot make contributions.""
No, it's not exempt. The limitation has to do with the type of account ("entity type" in section 25B(d)(2)(A) of the tax code) and has nothing to do with whether you are presently able to make contributions to that account. Distributions from a 403(b) paid to the participant or a spouse beneficiary within the testing period always count. See Chapter 3 of IRS Pub 590-A. Congress put this limitation into the tax code to prevent people from claiming the credit under circumstances that would not result in an increase in voluntary retirement savings in qualified retirement accounts.
