How to Get Military Severance Pay Tax Recoupment

Military severance pay is a one-time, lump-sum payment for service members who are involuntarily separated from the armed forces. This payment is considered taxable income in the year it is received, meaning federal and state income taxes are withheld before it is disbursed. The amount is reported on the service member’s tax forms and is subject to the same tax rules as regular wages. However, former service members may later qualify to have these taxes refunded through a specific recoupment process.

Eligibility for Tax Recoupment

The ability to recoup taxes on military severance hinges on reclassifying the payment as non-taxable disability compensation. This can happen through two pathways. The first is if the separation was due to a combat-related injury, as payments for injuries or sickness from active service in a combat zone are not considered gross income and are not taxable.

A more common scenario involves veterans who received severance for non-combat reasons but were later awarded a disability rating by the Department of Veterans Affairs (VA). If the VA determines a veteran has a service-connected disability, the previously taxed severance pay can be retroactively considered non-taxable because the law treats it as disability compensation. The VA’s determination and the effective date of the disability rating are the basis for this reclassification.

It is important to distinguish between refunds from the Defense Finance and Accounting Service (DFAS) and the IRS. If the VA disability rating is awarded in the same calendar year that the severance pay was received, the veteran can request a refund of withheld taxes directly from DFAS. This request must be received and processed by DFAS before the end of that calendar year. For all prior tax years, the veteran must file a claim for a refund with the IRS.

The Combat-Injured Veterans Tax Fairness Act of 2016 addressed this issue directly. It acknowledged that since 1991, the Department of Defense had improperly withheld taxes from severance payments for many veterans who were later deemed disabled. The Act created a special window for veterans separated after January 17, 1991, to file for a refund, even if the normal statute of limitations had expired.

Information and Documents Needed to File a Claim

The primary document needed is the DD Form 214, Certificate of Release or Discharge from Active Duty. This document provides the official record of the veteran’s service, including the date and reason for separation, establishing that the individual received severance. Also required is the official disability determination letter from the Department of Veterans Affairs. This letter is the primary evidence that qualifies the severance pay for non-taxable status and must clearly state the veteran’s disability rating and its effective date.

You will also need documentation from the Defense Finance and Accounting Service (DFAS) that details the exact amount of the severance paid and the amount of federal income tax that was withheld. This is often a specific letter issued by DFAS for this purpose, but a final Leave and Earnings Statement (LES) can also be used. A copy of the original Form 1040 tax return for the year the severance was received is also necessary to show the IRS how the income was initially reported.

With these documents gathered, complete Form 1040-X, Amended U.S. Individual Income Tax Return. You should write “Disability Severance Payment” or “St. Clair Claim” at the top of the form. On the line for Adjusted Gross Income (AGI), enter the AGI from your original return and then adjust it by subtracting the full amount of the severance pay. In Part III of the form, you must provide a clear explanation for the change, such as noting the exclusion of military disability severance pay.

The Claim Submission Process

Assemble your claim package and send copies of your supporting documents with the completed Form 1040-X, keeping the originals for your records. The package must be mailed to the IRS. Veterans should verify the most current IRS guidance to see if a special address is still designated for these claims to avoid processing delays.

Generally, a taxpayer has three years from the date they filed their original return or two years from the date they paid the tax, whichever is later, to file a Form 1040-X. The Combat-Injured Veterans Tax Fairness Act of 2016 created a special extended filing window, allowing eligible veterans one year from a notice letter sent by the Department of Defense in 2018 to file a claim. While that specific window has closed, the standard statute of limitations may still apply for more recent separations.

After mailing the claim, veterans should be prepared for a lengthy wait. The IRS processing time for these specific amended returns can be several months or longer due to the manual verification required. The IRS may send correspondence requesting additional information or clarification. Once the claim is approved, the refund will be issued either as a paper check or a direct deposit, depending on the information provided on the Form 1040-X.