VA Disability compensation is not part of your military retired pay, so it is not reported on your DFAS Form 1099-R and is not  reported anywhere on your tax return. Since the VA compensation never shows up on your tax return, it doesn't need to be taken off your tax return.

Since VA Disability compensation is not taxable, you just get a direct deposit every month - no tax documents are issued, just an annual  VA Award Letter every December (or January).

Are we to deduct our VA disability compensation from military retirement when reporting the 1099-R since it does not reflect any of the VA compensation? Since I have the VA waiver, I feel it is incorrect to report wages that I did not actually receive as income. I am not eligible for CRDP and do not keep both pays since I did not complete 20 years of service after being given a medical retirement. Being a 90% disabled veteran, I only receive about $100 per month of military retirement and about $1900 (tax free) from the VA. My 1099-R accounts for taxable income I did not receive since it was waived from the VA before I was paid. Therefore, if I enter the amount instructed on my 1099-R, I will be paying taxes on income I never actually received because it only displays the number (~$2000 per month) before VA compensation deduction occurred. I feel it is wrong to report the forms $24,000 when I only received $1,200 in taxable retirement income ($100 X 12 months of military retirement pay). Based on these numbers, would I be correct to report the $1200 since that did not include VA compensation? 

 Also, as previously stated, I understand that VA compensation is paid separately and is not reported with military retirement on the 1099-R so it appears like we have to make this correction since the agencies do not talk to each other (solely based on the 1099-R) and it would be incorrect to report taxes on money that is not taxed.

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