Do You Pay Taxes on Military Disability?

Military disability benefits offer support to service members and veterans who have sustained injuries or illnesses due to their service. Understanding which military benefits are subject to federal income tax and which are exempt helps individuals manage their financial planning.

Tax-Exempt Military Disability Payments

Military disability payments are not subject to federal income tax. These include disability compensation and pension payments received from the Department of Veterans Affairs (VA) for disabilities paid to veterans or their families. These tax-free benefits also extend to grants for homes specially designed for wheelchair living and grants for motor vehicles for veterans who have lost their sight or the use of their limbs. The Internal Revenue Service (IRS) instructs veterans to exclude these VA-administered benefits from their income.

Military disability retirement pay can also be tax-free if specific conditions are met. This applies if the service member was entitled to receive a disability payment before September 25, 1975, or was a member of a listed government service or its reserve component, or under a binding written commitment to become a member, on September 24, 1975. Payments for a combat-related injury or sickness are also excluded from taxable income. A combat-related injury results directly from armed conflict, takes place during extra-hazardous service, occurs under conditions simulating war, or is caused by an instrumentality of war.

If a service member retires based on years of service but later receives a retroactive service-connected disability rating from the VA, their retirement pay for that retroactive period can be excluded from income. This exclusion applies up to the amount of VA disability benefits they would have been entitled to receive. The IRS confirms that Combat-Related Special Compensation (CRSC) provides tax-free payments to retired veterans with combat-related disabilities. CRSC is distinct from other forms of military retirement pay.

Military Benefits Subject to Taxation

While disability benefits are largely tax-exempt, other types of military income and benefits are taxable. Regular military retirement pay, which is based on age or length of service, is considered taxable income for federal purposes. This contrasts with disability retirement pay and VA benefits, which may be partially or fully excluded. The portion of retirement pay not directly attributed to a service-connected disability remains taxable.

Wages and salaries earned from active duty or reserve service are also subject to federal income tax. These earnings are treated similarly to civilian employment income for tax purposes. Some allowances or benefits may also be taxable depending on their nature and governing tax laws.

Concurrent Retirement and Disability Pay (CRDP) is another example of a military benefit that is taxable. CRDP restores military retired pay that would otherwise be waived to receive VA disability compensation. While it allows recipients to receive both their full retired pay and VA disability, the retired pay component remains subject to taxation, unlike the tax-free VA disability portion.

Tax Reporting for Military Disability

Tax-exempt military disability payments do not require specific reporting on federal income tax forms. Recipients will not receive a Form W-2 or Form 1099-R for these tax-free disability benefits. The IRS does not require individuals to claim VA disability as part of their gross income when filing federal tax returns.

For military retirement pay that is taxable, recipients will receive a Form 1099-R from the Defense Finance and Accounting Service (DFAS). This form reports the distribution from pensions, annuities, or retirement plans, and it will distinguish between taxable and non-taxable portions if applicable. If a veteran’s disability rating is increased retroactively by the VA, they may be eligible to claim a federal tax refund for previous years by filing an amended return, specifically Form 1040-X.

Maintaining thorough records of all disability determinations and communications from the VA and DFAS is advisable. This documentation can be important if there are any questions regarding the taxability of payments or if an amended return is necessary. Consulting with a tax professional who specializes in military benefits can provide personalized guidance and ensure accurate tax compliance.