You are correct- If you receive a disability pension based on years of service, in most cases, you must include it in your income. However, if the pension qualifies for the exclusion for a service-connected disability, you do not include in income the part of your pension that you would have received if the pension had been based on a percentage of disability.
You can adjust the amount reported on your 1099-R to reflect only the taxable portion- with a caveat, because the IRS uses computers to check for discrepancies in income as reported as reported on your 1099 and 1040, so please keep copies of your VA determination in case the IRS contacts you about this. (They are supposed to be able to screen out the 1099-R from DFAS but sometimes they do not.)
@JoeB_271
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