Can taxable military retirement be reduced by the percentage of a VA disability rating?
A client retired from the military and receives a retirement pension for length of service and also has a 30% VA disability rating. Can he reduce his taxable retirement military pension by the percentage of his VA disability rating?
Q. Can a client who receives a military retirement pension reduce the taxable pension by the percentage of his disability rating from the VA?
My client, Roger, is retired from the military. He retired in 2016 and is receiving a length of service pension from Defense Finance and Accounting Services (DFAS). He also applied for disability through the Department of Veterans Affairs (VA) and received a 30% disability rating. In 2019 he started receiving compensation from the VA as well. Another military retiree told him he can reduce his taxable DFAS pension by the percentage of his disability rating. He received a 1099-R only from DFAS; he did not receive any other tax documents from the VA. Can my client reduce his DFAS pension by 30% (his VA disability rating)?
A. No, he cannot. His retirement pension is already adjusted for any tax-free VA disability compensation.
This is a very common question from taxpayers who retire from the military. In short, no, your client cannot reduce his length of service pension paid by DFAS and reported on Form 1099-R by using the disability rating given to him by the VA.
Military disability retirement
When a member of the military retires from the military, and eligibility requirements are met, they can either retire according to years and age, referred to as “length of service,” or due to disability. The determination of their retirement is made by their branch of service, or the Department of Defense (DOD), rather than by the VA. If a military member retires from the military disabled, having been determined as such by the DOD, their entire military pension is not taxable under §104(a)(4). Generally, §104(a)(4) excludes from gross income amounts received for personal injuries or sickness resulting from active service in the armed forces. In this situation, the military retiree would not receive a 1099-R for their disability pension.
VA disability compensation
On the other hand, if a military member retires from the military for length of service, and DOD has determined they are not disabled, but they believe they are entitled to some disability compensation, they can apply for disability compensation with the VA. This is an entirely different process. If the VA determines they are disabled, they may be given the option to receive VA disability compensation in place of their length of service pension. VA disability compensation is tax free.
Consequences of accepting or rejecting VA disability compensation
If they accept the VA disability compensation, they are required to affirmatively waive a portion of their length of service pension in favor of the tax free VA disability compensation under §122. Once they do this, DFAS will reduce their length of service pension and not report the VA waiver amount on the military retiree’s 1099-R. They will then begin receiving compensation from both DFAS and the VA throughout the year. At tax time, the VA will not send them a tax document related to their VA compensation because it is not taxable.
If the military retiree chooses not to accept the VA disability compensation, and they do not waive a portion of their length of service pension, they are not entitled to manually adjust their DFAS pension by the disability rating given to them by the VA.
From the facts you’ve given, it appears Roger has accepted the VA disability compensation. In doing so, his DFAS pension should already be adjusted by any tax free disability compensation he is receiving even though the tax free compensation is not reflected in his current 1099-R. If he believes this is not the case, he needs to contact DFAS or DOD to have the form corrected.
The situation you describe is one type of retirement-disability combination. In some instances, taxpayers may qualify for concurrent retirement and disability benefits (CRDP). Eligibility for disability benefits, from the VA alone or from both DFAS and the VA can be complicated and present difficult tax issues.
To properly apply the retirement and disability rules to Roger and other military retirees, here are some questions you can ask your clients to better understand their situations and how to proceed:
- What was the characterization of the taxpayer’s retirement from the military?
- Was it for length of service? or
- Was it due to disability?
- Did the taxpayer apply for disability pay from the VA after they retired from the military or before?
- Was the taxpayer given a disability rating from the VA? If yes:
- Did the taxpayer accept the VA disability compensation pursuant to the disability rating and waive their pension income equal to this amount?
- Does the taxpayer have records of the VA payments made during the year? This would not be a on an official tax form, but maybe in the form of a check stub or direct deposit.
- Was the disability rating made retroactive by the VA?
- Does the taxpayer have a DFAS account statement that breaks down the payments they receive each month? If so, does this statement have a “VA WAIVER” line item?
For an example of a retroactive disability determination per a settlement appeal to the IRS, please see Appeals Settlement Guidelines.