Does Kentucky Tax Military Retirement?
Understand how Kentucky's pension income exclusion applies to military retirement and survivor benefits, potentially reducing your overall state tax liability.
Military retirees in Kentucky are subject to specific state tax regulations. The state provides a tax benefit that can reduce the amount of military retirement pay subject to taxation, though the final treatment depends on factors like total retirement income.
Kentucky’s Pension and Retirement Income Exclusion
Kentucky law provides a substantial exclusion for pension and retirement income, which directly benefits military retirees. For the 2023 and 2024 tax years, a taxpayer can exclude up to $31,110 of their retirement income from their Kentucky adjusted gross income. This exclusion applies to all forms of qualifying retirement distributions, including those from federal government pensions like U.S. military retirement pay.
The exclusion is applied on a per-taxpayer basis, not per household. If both spouses on a joint return receive their own qualifying pension income, each can claim an exclusion up to the $31,110 limit on their respective incomes. For example, if a military retiree receives $50,000 in military retirement pay, the first $31,110 is subtracted, and only the remaining $18,890 is subject to Kentucky’s income tax. Retirees whose total pension income is less than or equal to $31,110 will owe no state tax on that income.
A special provision exists for individuals who retired before January 1, 1998. For these retirees, their military retirement pay is completely exempt from Kentucky income tax, regardless of the amount. Those who retired after December 31, 1997, but had service time before 1998, may be eligible to exclude an amount greater than the standard $31,110. The calculation for this additional exclusion is based on the percentage of service credit earned before 1998.
Qualifying for the Pension Income Exclusion
Eligibility for the pension income exclusion on military retirement pay is straightforward. The primary requirement is the receipt of payments from the U.S. Armed Forces retirement system. These payments, reported on federal Form 1099-R, are considered qualifying income for the exclusion.
A distinction is made for military disability retirement pay. Payments received as a pension, annuity, or similar allowance for personal injury or sickness resulting from active service are generally not included in taxable income at the state level. These amounts are often fully nontaxable under separate rules and would not be part of the calculation for the standard $31,110 pension exclusion.
The exclusion applies to various forms of retirement income, not just military pensions, including distributions from IRAs and 401(k)s. For military retirees, their armed forces pension is the most common source of income that qualifies for this tax subtraction in Kentucky.
Claiming the Exclusion on Your Kentucky Tax Return
The exclusion is not automatic; it must be calculated and claimed on the appropriate forms. The primary form for this purpose is Kentucky Schedule P, Pension and Annuity Income Exclusion. This schedule is a required attachment to the main Kentucky individual income tax return, Form 740.
On Schedule P, the taxpayer reports their total federally taxable pension income and subtracts the allowable exclusion amount, up to $31,110. The resulting taxable portion is then transferred from Schedule P to Schedule M, Kentucky Federal AGI Modifications. This schedule ultimately adjusts the income reported on the main Form 740.
For those who may qualify for a larger exclusion due to service before 1998, Schedule P includes a worksheet to calculate the specific exempt percentage. Taxpayers will need their retirement date and service credit information to complete this calculation accurately. The Kentucky Department of Revenue also provides a downloadable spreadsheet to assist with this specific calculation.
Treatment of Survivor Benefit Plan Payments
Payments from the Survivor Benefit Plan (SBP), which provides an annuity to eligible survivors of deceased military members, are also eligible for the Kentucky pension income exclusion. These SBP payments are treated as qualifying retirement income for Kentucky tax purposes.
The surviving spouse who receives the SBP annuity is the individual who claims the exclusion on their own Kentucky tax return. They can exclude up to the maximum allowable amount of $31,110 from their SBP income. If the surviving spouse has other forms of qualifying retirement income, the SBP payments are combined with that income, and the total is subject to the single $31,110 exclusion limit.