I know CA treats a HSA account as an ordinary brokerage account so capital gains and income/dividends are taxable. To avoid tax I invested in a Treasury bond fund since interest earned from this fund is not taxable by CA.
However on the HSA earnings portion of the CA adjustments it just asks for interest, dividends, and capital gains earned. It doesn't ask if any interest/dividends were from US obligations.
How do I adjust this so I don't pay tax on CA-exempt interest?
If you are sure that CA does not tax the investments inside your HSA, then I would not enter anything in the screen that is titled "Enter Your Health Savings Account Earnings".
As you can see, there is no way in the software to easily enter earnings while making them non-taxable.
Instead, I would suggest that you write up a note to yourself about why you did not enter the CA-exempt interest inside your HSA (because the software would have taxed it), print it, and stick it in your tax file in case anyone ever asks.
The only other way would be to enter the interest earned in the HSA window, then enter a negative amount elsewhere on the return as an adjustment, but I think that this is more likely to confuse people than help.
After all, if you don't enter the non-taxable interest, then your CA taxable income will be correct, which is what we want.
States are not allowed to tax income earned from Federal bonds. CA says this in https://www.ftb.ca.gov/forms/2017/17_1001.pdf page 5
Federal law requires the interest earned on federal bonds (U.S.
obligations) to be included in gross income. California does not
tax this interest income. The following are not considered U.S.
obligations for California purposes: Federal National Mortgage
Association (Fannie Mae); Government National Mortgage
Association (Ginnie Mae); or Federal Home Loan Mortgage
Corporation (Freddie Mac).
Don't enter any interest that is non-taxable in CA.
In this case, on the CA screen that asks for interest, dividends, and capital gains, just don't enter any interest which is not taxable in CA. The federal screen asking for interest is more sophisticated because of the need to know what kind of interest it is, but the CA screen just needs to know if it is taxable or not in CA. If it's not taxable in CA, just don't enter it.