Deductions & credits

Yes, there is a possibility that discrepancies between Form 3520 and Form 1099-INT may raise red flags with the IRS. The IRS uses a computer-based Discriminant Information Function (DIF) scoring system to detect inconsistencies and potential audit triggers. If an withdrawal reported on Form 3520 significantly differs from the income reported on Form 1099-INT, it may prompt the IRS to examine your return. 

Within the Turbo Tax program, there isn't a section to report discrepancies between 3520 and amount reported on 1099 INT.  With this in mind, you have several options to report this.

1. Report in the manner that I suggest. If the IRS has a question later, you can explain to them the difference.  Since your total withdrawal amount does not significantly differ from the taxable interest, the likelihood of raising a red flag may be remote.
2. Instead of electronically filing your return, you may print and mail the return along with a detailed statement explaining the difference between the withdrawal reported on the 3520 and the 1099 INT.

Here is a third option you may do that will allow you to file electronically and report the discrepancy. 

1. Log into your account
2. Select Wages and income
3. Less Common income
4. Miscellaneous Income, 1099-A, 1099>start
5. Scroll to the bottom of the page to Other Reportable Income
6. Other taxable income, answer yes
7. Then give a brief description  and the amount listed. In the description, Call it a distribution reported on 3520 and list the full amount of 2000.
8. Once this appears in a summary screen, click on the Add Miscellaneous Income Item. In the description, report this non-taxable amount of distribution and report this as -1000. Then $1000 will be the taxable income that is reported on the 1040. 

This third option still may trigger an examination by the IRS but at least, you are able to offer a brief explanation between the full distribution and the taxable amount of the distribution. In the this option if you, decide to use this, you can be as detailed as possible along there is enough space for your detail.

My suggestion is to report this as taxable interest in my original advice and if the IRS has any questions, you can take action at that time. This would be preferable if you wish to file electronically.  if you are not concerned about filing this electronically, then prepare a detailed explanation if you wish.