There has been some mention in the press recently about a tax break for disabled vets. To explain this tax break let’s start with the basics of how retirement pay is taxed for a disabled veteran. First off, disability pensions for a veteran are non-taxable, but regular retirement pay of a veteran is subject to federal income tax. So, for a totally disabled veteran their retirement pay is completely non taxable. A partially disabled veteran would pay tax on their regular pension but the portion that represents retirement disability pay is not taxable. Typically, this is accounted for on the 1099-R received by the retired veteran. For example, a retired veteran with a 30% disability and annual pension of 30,000 would pay tax on 21,000. This 21,000 taxable amount would be reflected on the 1099-R issued by the Department of Defense
However, many combat injured veterans received severance pay upon leaving the military but their disability rating was not determined until some future date. As a result, the severance pay was listed as fully taxable in the year it was received. As an example, let’s say an injured combat veteran received 25,000 in severance pay in 2015, but his disability rating was not completed until 2016. In 2015, he would have received a 1099-R showing that the 25,000 was taxable. In 2016 he is determined to be 50% disabled. For 2016 and each succeeding year his 1099-R would reflect that 50% of his pension is tax free, but what about 2015? 50% of his severance pay should have been non-taxable and he would have to file an amended return to get his refund.
I have filed amended returns for wounded veterans with this exact situation, but there are many veterans who were unaware of this tax benefit. In late 2016 Congress addressed this issue and passed a law allowing disabled vets who had retired since 1991 an opportunity to claim those missed refunds. As part of the Combat Injured Veterans Tax Fairness Act, the Department of Defense has issued over 130,000 letters to disabled veterans who may be entitled to refunds for overpaying the tax on their disability severance pay. Affected veterans will have one year from the receipt of the letter to file any needed amended returns to claim their refunds.