Where do I add window casing with a replacement window
Casing should almost always lap onto the current window jamb. It's the final edge for the wall finish. In your case, you have a slight level variation, which is usually handled with an extension jamb. You can also create a rabbet in your casing, which would result in an extension integrated into the casing. 

In any case, the gap between the jambs should be insulated with fiberglass or low-expansion spray foam, and the casing should lap over the gap and onto the new jamb. 

Ideally no joints are left flush. Each step should have a "reveal", creating a multi-level appearance. Flush joints are odd looking and difficult to get perfect.