As tax season approaches, veterans may want to review the tax liabilities associated with their VA benefits. Which benefits are tax-free, and which aren’t? To keep it short and simple: your VA disability benefits are generally tax-free.
Tax-Free VA Benefits
In Publication 907, the IRS instructs veterans to exclude any of the following VA-administered benefits from their income, meaning they are non-taxable:
- Education, training, and subsistence allowances.
- Disability compensation and pension payments for disabilities paid either to veterans or their families.
- Grants for homes designed for wheelchair living.
- Grants for motor vehicles for veterans who lost their sight or the use of their limbs.
- Veterans’ insurance proceeds and dividends paid either to veterans or their beneficiaries, including the proceeds of a veteran’s endowment policy paid before death.
- Interest on insurance dividends left on deposit with the VA.
- Benefits under a dependent-care assistance program.
- The death gratuity paid to a survivor of a member of the U.S. Armed Forces who died after September 10, 2001.
- Payments made under the compensated work therapy program.
- Any bonus payment by a state or political subdivision because of service in a combat zone.
Military Disability Retirement Pay
Military disability retirement pay is also a non-taxable benefit, paid as a pension, but which shouldn’t be confused with VA disability compensation. Veterans qualify for this tax-free benefit if they meet one of the following criteria, according to IRS Publication 525:
- You were entitled to receive a disability payment before September 25, 1975.
- You were a member of a listed government service or its reserve component or were under a binding written commitment to become a member, on September 24, 1975.
- You receive the disability payments for a combat-related injury. This is a personal injury or sickness that:
- Results directly from armed conflict;
- Takes place while you’re engaged in extra-hazardous service;
- Takes place under conditions simulating war, including training exercises such as maneuvers; or
- Is caused by an instrumentality of war.
- You would be entitled to receive disability compensation from the VA if you filed an application for it. Your exclusion under this condition is equal to the amount you would be entitled to receive from the VA.
Regarding item 4, if you receive a disability pension based on your years of service, you must include it in your income. However, if you qualify for service-connected disability benefits and your pension allows for this exclusion, you can exclude from your income the percentage of compensation entitled to you by your VA-assigned disability rating. The rest of the pension, however, is taxable.
In cases where veterans receive retroactive service-connected disability ratings, any retirement pay during that retroactive period is tax-free, subject to the statute of limitations (typically 3 years except under special circumstances). Veterans can apply for refunds of taxes paid by submitting 1040-X forms for each year of that retroactive period.
Professional Tax Assistance for VA Benefits
Due to the complexity of the tax code and the uniqueness of every veteran’s situation, we advise you to consult a qualified CPA or tax professional with your questions and concerns. These professionals are in the best position to help make sense of your situation and ensure that your taxes are properly prepared and your compensation is appropriately protected.
In cases where you need assistance with your VA disability claim or wish to appeal an unfavorable decision, you may reach us at 844-VET-LAWS or contact us online.