How New Law Affects Taxes for Gold Star Families

Families of military members killed in the line of duty may face a huge tax increase thanks to changes hidden in a new tax law.

Survivors of fallen military members are entitled to benefits from both the Department of Veterans Affairs and the Department of Defense. This is in the form of Dependency and Indemnity Compensation (DIC) from the VA (also known as the Death Pension), and the Survivors Benefit Plan (SBP) from the military.

The DIC payment is tax free, because it is a benefit. The SBP payment is taxable, since it is a retirement payment.

DIC is around $1,300 a month while SBP is paid at the rate of 55% of a deceased member’s base pay, so SBP payments are almost always higher than DIC payments, except for survivors of deceased military members who were E-4 or below.

Related: This Year's Tax Cut Cost Some Gold Star Families Dearly

Laws against double-dipping say that no one can get more than one federal government payment for the same thing, so surviving family members who are entitled to both DIC and SBP normally have their SBP payment reduced by the amount of the DIC payment. This has become known as the "widows' tax." Many groups have long argued that this is unfair and lobbied Congress to end it.

However, until it ends, some families had found a way to get around this widows' tax.

If there were children, the surviving spouse would designate them as recipients of the taxable SBP payment, and the parent would receive the tax-free DIC payment. That's because children are usually taxed at a lower rate than their parents since they have no other income.

A provision of the Tax Cuts and Jobs Act of 2017 has effectively nipped this practice in the bud.

Under changes included in the tax law, government payments that children of fallen military members receive are now considered unearned income. As such, they are taxed at the same rate as trust funds and estates. In 2018, this is the highest marginal tax bracket of 37%.

Previously, these retirement payments could be considered regular income and taxed at a lower rate, possibly as low as 15%. Many Gold Star families are reporting that their 2018 income taxes on SBP payments have nearly tripled from the 2017 amounts.

Until the widows' tax ends, or the tax law is further amended to remove this huge tax increase, many children who lost a parent in the war will end up paying higher income taxes on their survivor benefits than someone making $500,000 annually.

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