Under most circumstances, military retirees are responsible for paying federal income tax. The IRS taxes military retirement pay as a pension. Since military pay is taxed as a pension, the IRS can tax all or part of your monthly retirement pay. If your military pay includes disability, however, that portion of your pay in many cases is not taxable.
According to the IRS, if you are receiving military retirement based on your time in service, your retirement is taxable. When filing your tax return, list your retirement income under "Pensions and annuities" on line 16a or 16b of Form 1040 or 12a or 12b on the 1040A. The IRS also mentions that you shouldn't include any contribution to your child or spouse under the Survivor Benefit Plan in the amount your report on your tax return. For example, if you receive $10,000 in retirement for the year and you contributed $1,000 to the Survival Benefit Plan, then $9,000 is considered taxable by IRS standards.
Disability is not taxable if you incurred any personal injury or sickness while serving in any of the Armed Forces. If your disability pension is based on years of service, however, the IRS considers it taxable. The percentage of your disability that is considered service-connected is what you will exclude from your income; the rest is considered taxable. A service-connected disability is injury or sickness that occurred while actively performing military service. If you were receiving disability pay as of Sept. 25, 1975, you are also exempt from listing disability pay as taxable income. Also, if you were active duty or reservist in any armed service on Sept. 25, 1975, you may also qualify for a disability tax exemption.
The Defense Finance and Accounting Service located in Cleveland, Ohio, calculates the amount of money that should be withheld from your retirement each pay period. Each year, no later than the end of January, you will receive Form 1099-R, which lists the amount of income you received and also the amount of tax withheld for that calendar year. If 100 percent of your disability was exempt from taxation, then you will not receive Form 1099-R since you are not required to report tax-free income to the IRS.
Retroactive VA Determination
If you receive military retirement based on your years of service and it is later determined by the Veterans Administration that you should have a service-connected disability rating, the VA may issue a retroactive determination. If you are paying taxes on your disability income, you can file an amended tax return using Form 1040X to adjust your taxes for the period the VA considered your disability service-connected. For each amended tax return you file, include a copy of the Veterans Administration determination letter that documents the retroactive determination. The letter should also include the amount withheld as well as the effective date you were considered service-connected disabled.
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