What Is the Qualified PSO Exclusion and How to Claim It?

The Qualified Public Safety Officer (PSO) Exclusion is a federal tax benefit established under the Pension Protection Act of 2006. It allows retired law enforcement officers, firefighters, and other eligible public safety personnel to exclude a portion of their retirement income from federal taxation. Specifically, this provision permits an exclusion for amounts used to pay for qualified health and long-term care insurance premiums. The purpose of this tax rule is to provide financial relief to those who have served in public safety roles by reducing their taxable income in retirement.

Eligibility Requirements for the Exclusion

To qualify for this tax exclusion, an individual must meet several criteria defined by the Internal Revenue Service (IRS). The primary requirement is status as a “qualified public safety officer,” which includes individuals who served a public agency as a:

• Law enforcement officer
• Firefighter
• Chaplain
• Member of a rescue squad or ambulance crew

The definition is tied to the Omnibus Crime Control and Safe Streets Act.

A condition for eligibility is the reason for separation from service. The officer must have left their position after reaching the normal retirement age as defined by their plan, or they must have separated due to a disability. The retirement income itself must originate from a governmental retirement plan, such as a defined benefit pension plan, a 403(b) plan, or a 457(b) plan.

The exclusion applies specifically to premiums for qualified health insurance, which includes accident, health, and long-term care insurance. This coverage can be for the retired officer, their spouse, or their dependents. The funds used for these premiums must be distributed from the eligible governmental retirement plan.

Claiming the Exclusion

The procedure for claiming the PSO exclusion has a requirement regarding how insurance premiums are paid. For the exclusion to be valid, the retirement plan must distribute the funds used for the premiums. A recent change in law now allows for this distribution to be made either directly to the insurance provider or to the retiree, who then pays the provider.

The amount of the exclusion is capped annually. A retiree can exclude the lesser of the total amount of insurance premiums paid or $3,000. For example, if a retired officer has $4,000 in qualified insurance premiums paid from their pension distributions, they can only exclude $3,000 from their gross income. If their premiums for the year totaled $2,500, their exclusion would be limited to $2,500.

When filing a federal income tax return, specific reporting is necessary. On Form 1040, the retiree reports the total pension distribution on the line for pensions and annuities. On the line for the taxable amount, they report the reduced figure after subtracting the excluded premium amount (up to the $3,000 limit). To notify the IRS of the reason for this difference, the filer must write “PSO” on the dotted line next to the entry for the taxable amount. The Form 1099-R issued by the retirement plan will not reflect this exclusion, so it is up to the taxpayer to make the correct adjustment on their return.

Coordination with Other Tax Provisions

The PSO exclusion interacts with other areas of the tax code. One of the most direct interactions is with the medical expense deduction. Any insurance premiums that are excluded from income under the PSO rule cannot also be counted as medical expenses for the purpose of itemizing deductions on Schedule A.

The tax treatment of retirement income can differ significantly at the state level. While the PSO exclusion is a provision of federal tax law, its application to state income taxes is not automatic. Retirees should verify their state’s tax regulations to determine if the excluded amount must be added back to their income for state tax purposes. Consulting a local tax professional can clarify how this federal exclusion impacts their state tax obligations.