If the IRS is saying "that tax is owed on the 529 distribution amount prior to the 60% being applied", they're not giving you credit for any educational expenses.
You've done nothing wrong (nor has TurboTax [TT]). We're seeing this frequently (it happened to me, personally). Apparently, the IRS has created a problem by not having a form to report the situation where the taxpayer uses all the 529 plan distribution for qualified expenses. Even though you probably entered the 1099-Q in TT, nothing about the 1099-Q went anywhere on the actual IRS forms (if part of it was taxable, the taxable amount (but not any calcs) went on line 8 of schedule 1)
At least two users have reported receiving a CP2000 letter, from the IRS, on 529 distributions. They replied that their child was in college and the distributions were for qualified expenses, which they listed, but they did not provide receipts.. They later received a notices saying they were in the clear. Others have reported that just sending copies of school billing statements satisfied the IRS.
If you have a situation where some of the earnings were taxable, you may have to manually recreate the calculations on the TT worksheet (or contact TurboTax support to help you locate the work sheet). Follow the example above to show the calculation of the taxable amount.
Even if TT made a mistake (and that's unlikely), they only owe you for the penalty and interest on the tax, not the actual tax.
To contact TurboTax (TT) support:
https://turbotax.intuit.com/support/contact/index.jsp
In the search line enter some keywords or question without quotes. On the next page, skip the suggested topic links and scroll down until you see CALL US. It should show the wait times. Week days 5 AM - 5 PM Pacific time.
