Editor's note: Register today for MOAA's Feb. 26 Tax Talk webinar.
The combination of service retired pay and VA disability pay causes some tax confusion.
The tax rules for tax-free service retired pay are specific and limited. If you have taxable income reported to the IRS on a 1099R by your pay agency, it’s taxable. The simple receipt of VA disability compensation does not allow you to declare your service retired pay tax-free.
Service retired pay based on age or length of service is taxable and must be included in your taxable income. Receiving VA disability compensation does not change this fact.
Any payments or benefits administered by the VA are tax-free and not included in your income. This is why you do not receive a 1099 tax form for VA payments and benefits, as these are not reported to the IRS.
Any retired pay based on a service disability rating is removed from retired pay by the “VA Waiver” when a member also receives VA compensation for the same disabilities. Double dipping laws do not allow two government payments for the same event. The VA Waiver means you are surrendering your retired pay to receive VA compensation, thereby eliminating double dipping situations.
When a member receives VA disability compensation and the VA compensation is subtracted from retired pay by the VA Waiver, “concurrent receipt” law ensures members receive at least enough retired pay to compensate them for their years of vested service. However, not everyone is covered by the concurrent receipt law. See this article for information on eligibility.
Concurrent receipt programs such as Concurrent Retirement and Disability Pay (CDRP) and Combat-Related Special Compensation (CRSC) do not restore retired pay based on a service disability rating when the member is also receiving VA disability compensation. In other words, CRDP and CRSC do not negate the double dipping law—you still can’t receive two disability pays.
- CRDP is taxable. It eliminates the VA Waiver from retired pay, thereby returning your taxable retired pay.
- CRSC is a tax-free reimbursement of pay that is removed by the VA Waiver.
- Both programs are administered by your pay agency; the Defense Finance and Accounting Service or the Coast Guard.
Here are some situations that would allow for service retired pay to be tax-free:
- You retired with a service disability rating prior to Sept. 25, 1975, or eventually retired with a service disability rating if you were serving on Sept. 24, 1975.
- You receive retired pay due to a service disability rating specifically for combat-related issues. In this case, your tax-free retired pay would be in the form of CRSC. Any retired pay other than CRSC is taxable.
- You choose not to accept VA disability compensation for your service disabilities. By not accepting tax-free VA compensation, you can exclude an amount of taxable retired pay equal to the amount you would be entitled to receive from the VA. This requires proof of the awarded VA disability amount. In my opinion, there is no benefit in this strategy.
Finally, what about the Strickland Decision? The Strickland Decision applies to past taxed retired pay you received that is rendered tax-free by a retroactive VA disability compensation award — think of a retroactive VA Waiver event.
[MORE RESOURCES: MOAA's Members-Only Military State Report Card and Tax Guide]
In other words, you were paid and then paid taxes on previous retired pay. Your retroactive VA award would have changed the tax status of the past taxable income to tax-free income because a VA Waiver would have been applied to the past retired pay. You can file an amended tax return to recover taxes you paid on income that was made tax-free by the retro VA award. The catch: If you qualify for CRDP, you do not have an amended tax return situation because the retro CRDP eliminates the retro VA Waiver issue.
For more information, carefully interpret the words in IRS Pub 525, Military and Government Disability Pensions for details or consult a tax specialist.