I've heard of this before and seen it debated back and forth. I don't think there is a solid answer. However, the 1.25 qt seems to be what people drain out when they change the fluid for the first time. On the other hand, I have never heard of the transfer case blowing up when people run 3 qt of fluid in it.
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2008 Liberty Sport 4x4 Automatic
Jeepin By Al 4" Lift Kit
BFG KO2’s 245/75R16
Full MOPAR skid plates
Rock Lizard Skink Super Sliders
AtTheHelm Front Recovery System & Roof RackM116A3 Trailer build thread: viewtopic.php?f=72&t=77997