Here's a look at the laws that could wage a multipronged attack on your wallet and what you can do to prepare.
Military retirement pay based on age or length of service is considered taxable income for Federal income taxes. However, military disability retirement pay and veterans' benefits, including service-connected disability pension payments, may be partially or fully excluded from taxable income.
Soldiers with service-connected disabilities may be eligible for Federal income tax exclusions of veterans' benefits and disability pension payments.
Military Retirement Pay
Military retirement pay based on age or length of service is taxable and must be included as income for Federal income taxes. The amount a retiree pays to participate in the Survivors Benefit Plan (SBP) is excluded from taxable income. For Social Security tax purposes, military retirement pay is not considered earned income and no Social Security payroll taxes (also known as Federal Insurance Contributions Act (FICA) taxes) are withheld from military retirement pay.
Military Disability Retirement Pay received as a pension, annuity or similar allowance for personal injury or sickness resulting from active service in the armed forces should not be included in taxable income if any of the following conditions apply:
Veterans' benefits are also excluded from Federal taxable income. The following amounts paid to veterans or their families are not taxable:
Retroactive VA Disability Determination
If you retire from the Army based on years of service and are later given a retroactive service-connected disability rating by the VA, your retirement pay is excluded from income up to the amount of the VA disability benefits you would have been entitled to receive. You can claim a refund on any taxes paid on the excludable amount by filling an amended return on Form 1040x for each previous year during the retroactive period (subject to statute of limitations).
You may exclude 100% of any severance benefit from your income if you receive a lump-sum disability severance payment and are later awarded VA disability benefits. However, any lump-sum readjustment or other non-disability severance payment you receive upon your release from active duty must be included in your income even if you are later given a retroactive disability rating by the VA.
The statute of limitations for claims of retroactive disability is generally within 3 years of when a tax return was filed. However, in cases where a retroactive service-connected disability rating determination is received, the statute of limitations is extended by a 1-year period from the date of determination for claims for credit or refund that are filed after June 17, 2008. This special statute does not apply to any tax year that began more than 5 years prior to the date of determination.
For more information, visit Publication 525, "Taxable and Nontaxable Income," Special Rules for Certain Employees/Military regarding Federal taxes on military retirement pay or veterans' benefits maintained by the Internal Revenue Service.
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