I must have entered something incorrectly. I am being told only $2,937 of our $6,500 traditional IRA is deductible and we have a penalty. Help please.

If TurboTax is generating a penalty for this, it indicates that you had only $2,937 of eligible compensation to support the traditional IRA contribution.  Eligible compensation is generally income reported in box 1 of your W-2 (minus any amount in box 11) or net income from self-employment.  Net income from self-employment is your net profit from self-employment minus the deductible portion of your self-employment taxes.  Also, any deductible contributions that you make to a self-employed retirement plan reduce the amount of compensation available to support the IRA contribution.