For the purpose of your federal taxes, you're right that you can't use the same education expenses for tax-free 529 withdrawals and the Lifetime Learning Credit. See
Publication 970 for the rules about tax-free 529 withdrawals when you're also claiming the Lifetime Learning Credit.
But! It sounds as though you're putting money into a 529 to get the state tax credit, and then immediately spending it on education. Is that right? You could still take money out of the 529 to pay these expenses. Nobody's stopping you. It's just that any gains on the part of the withdrawal that went toward expenses that you also counted for the Lifetime Learning Credit would count as taxable income (but no 10% penalty: see exception 5 in
Publication 970). If you just contributed to the 529 recently, any gains would be minimal, so this shouldn't be a big deal.
The real question here is this: does the Indiana tax credit have a provision where you have to repay the 20% incentive if, at the time you withdraw from the 529, it doesn't count as a qualified distribution because your tuition was low enough that it all counted toward the Lifetime Learning Credit? This I can't answer. I know nothing about Indiana taxes.
Another thing to consider: for the purpose of 529s, "qualified education expenses" include room and board for students who are enrolled on at least a half-time basis. Are you? If so, your housing and food expenses would count in addition to your tuition. Also whether you're half-time or not, any money you spend on computer equipment or internet access you plan to use during your studies counts as a qualified expense for the 529.
