From my understanding from a conversation I had on the phone back in 1999 when I did this, since DFAS actually did pay the money, they are not going to change the 1099-R as it would not be legal for them to do so. It would also mess up their own accounting books since they did "in fact" pay the money from their funds, and not from VA funds. The IRS procedure allows DFAS to keep their books straight, while giving the taxpayer the tax relief they are legally entitled to.
