Let's give them a chance to finish the job, please.

is it typical not to plumb the wall before tile install?

Yes. Unless it's a super high-end job and it was discussed and specifically requested, they wouldn't do it. If the tile is plum then they did a good job. The gap will be caulked. Floating it with drywall mud will cost more.

contractor wants to grout the gap and paint over to match the wall. is this industry standard? what would mike holmes do?

Most grout companies make a color coordinated sanded caulk. The tile and wallboard intersection are dissimilar materials that expand and contract differently so grout will crack. Use the color coordinated caulk that dries to the color of the grout. It will expand and contract avoiding the crack issue.

No, no no.... don't put grout in there. Can you post a photo that is more pulled back. It's really hard to tell what the best solution would be from your photos.

I'd fill it with color matched silicone caulk and keep the caulk off the paint. If the gap is too wide, rip a strip of matching solid surface or other acceptable trim and caulk that into place. No grout; way too large for grout.