"But the municipality sent an 1099-NEC not a 1099-R, citing 'new rules' for NEC and because separating volunteers have the OPTION to cash the check and pay the tax, or roll it over."
That makes no sense. Forms 1099-R have always been treated that way by simply reporting a taxable distribution on the Form 1099-R and leaving it up to the taxpayer to report on their tax return whether it was rolled over to defer taxation or not. Form 1099-NEC is for reporting Nonemployee Compensation paid to independent contractors. Distributions from a qualified retirement plan are not compensation.
See the instructions for Form 1099-NEC which describe the usage of Form 1099-NEC:
https://www.irs.gov/instructions/i1099mec
Absent the municipality making a correction to report the distribution properly on Form 1099-R and to issue a corrected Form 1099-NEC to show that there was no nonemployee compensation, preparing a substitute Form 1099-R is the appropriate course of action.
