I think I finally understand your question "However, PTO carried over such distribution to California schedule CA (540) part 2 line 4 as an addition under column C. This increases CA itemized deductions on Line 18 Form 540." was something i just glossed over as being a red herring. 

Since CA does not recognize the HSA, all income from it is taxable, which they don't seem to pursue. All expenses paid from it ARE DEDUCTIBLE MEDICAL, if they would otherwise be medically deductible. No deduction = distributions are just like you dug the money out of your left pocket. What you are seeing is the correct representation of an additional medical deduction on CA, shown on Schedule CA.