Military veterans with a service-related disability are often eligible for a wide array of benefits through the Department of Veterans Affairs (VA). Those who receive benefits often have questions regarding the taxability of their benefits.
If you’re wondering, “Is VA disability taxable?” here’s what you need to know.
Is VA Disability Taxable?
The answer to “Is VA disability income taxable on the federal level?” is “no.” There aren’t any VA disability taxes to contend with if the funds are provided by the VA.
Internal Revenue Service (IRS) Publication 907 explicitly states not to “include disability benefits you receive from the Department of Veterans Affairs (VA) in your gross income.” It goes on to state that “disability compensation and pension payments for disabilities paid to veterans” administered by the VA are one of the income types not to list as part of your income.
Additionally, the benefits aren’t taxable regardless of a veteran’s disability rating. As a result, the tax situation is the same for veterans, even if their rating is below 100 percent.
For those who received retirement pay and later were assessed to have a service-related disability rating based on VA findings, the taxes on the associated portion of the retirement pay that was taxed prior to the determination is refundable. In this situation, IRS Form 1040x is required.
Additionally, there is a statute of limitations that restricts how many years you can go back and claim the overpaid taxes.
Is VA Disability Income Taxable by State?
While VA disability income isn’t taxable on the federal level, veterans living in states with state income taxes may ask, “Is VA disability payment taxable by the state?” Again, the answer here is “no.” As a result, veterans are not required to report their VA income benefits as part of their gross income when filing state taxes.
Again, this situation applies regardless of a veteran’s disability rating. Veterans with less than a 100 percent disability receive the same tax-free status for the associated VA benefits as those with a 100 percent rating do.
Veterans: Are you under 90% rated?
Winning approval for military service-connected injuries and illnesses can be a challenging process. Be confident that you’re getting the compensation that you medically, legally, and ethically qualify for.
How Taxes and Medical Discharge Payments Work
Veterans who received a lump-sum payment relating to a medical discharge often wonder if that money is taxable. Based on the Combat-Injured Veterans Tax Fairness Act of 2016, those who previously reported the money as part of their taxable income any time after January 17, 1991 – and paid taxes on those funds – can also request a credit or refund on the taxes paid.
What VA Benefits Are Tax-Free?
Generally, the vast majority of VA benefits are tax-free. IRS Publication 907 specifically lists the following VA benefits as non-taxable:
- Disability compensation and pension payments
- Educational and training allowances
- Subsistence allowances
- Wheelchair-related home grants
- Motor vehicle grants for accessible vehicles for veterans who lost limbs or sight
- Veterans’ insurance proceeds and dividends
- Insurance dividends interest left on deposit with the VA
- Dependent-care assistance program benefits
- Compensated work therapy program payments
VA benefits, as listed above, remain tax-free regardless of the veteran’s disability rating. Additionally, the VA benefits aren’t taxable even if the veteran works after separating or retiring.
However, taxes are owed on work-related income earned from other sources, and some other non-VA benefits are also potentially taxable.
Additionally, Special Monthly Compensation benefits aren’t taxable. Specific income provided to surviving parents, spouses, or children – such as Dependency and Indemnity Compensation – are also not subjected to taxation.
What VA Benefits Are Taxable?
Generally, all disability benefits coming from the VA aren’t taxable. However, certain other sources of funds are potentially taxable.
The most common example is military retirement pay, which is typically taxable.
However, a veteran’s disability rating may reduce the taxes owed. Generally, this depends on the amount of VA disability benefits received, the disability percentage, and a few other factors.
In most cases, taxable income is reduced in accordance with the amount of compensation received by the VA, so any remaining military retirement payments are taxed at the pension rate.
What to Do If Your Disability Rating Increases
VA benefits remain tax-free if your rating increases. If the amount you receive from the VA in connection to the disability increases, there are still no taxes owed.
Additionally, with a disability rating increase, veterans are potentially eligible for a veterans disability tax refund on taxes paid based on the old rate. Generally, this applies if the determination is retroactive or if the veteran is granted Combat-Related Special Compensation following an award of Concurrent Retirement and Disability Pay.
VA Disability and the Earned Income Tax Credit (EITC)
Along with wondering, “Is VA disability taxable income?” many veterans also want to know how their eligibility for other tax credits is impacted by VA disability. One primary example includes eligibility for the Earned Income Tax Credit (EITC).
The EITC is a refundable tax credit, creating opportunities for tax filers to receive back more than they paid in taxes. VA disability benefits aren’t considered earned income.
The same is true of military pensions. As a result, they don’t count toward the EITC. VA benefits also don’t eliminate or reduce the tax credit if the veteran has other income that does qualify.
Additional Tax Benefits Available to Disabled Veterans
Disabled veterans are potentially eligible for other tax benefits, particularly at the state level. For example, many states have property tax reductions for disabled veterans, reducing the amount of property taxes owed on qualifying homes.
Whether such a benefit is available and how it works varies by location, so it’s wise to examine property tax exemptions in your specific area.
Do Disabled Veterans Have to File Taxes?
Technically, disabled veterans or any other individuals without taxable income (any amount below the standard deduction) to report may not need to file taxes every year. Additionally, there isn’t a separate VA disability tax form to contend with in lieu of a traditional return.
However, filing federal and state taxes is still recommended.
At times, these annual returns are necessary to access specific credits or deductions, which is particularly vital if a veteran has other sources of income that result in a tax burden. Similarly, refundable tax credits are potentially available, but only if you file.
Filing returns is also helpful if your disability rating changes, altering your access to tax credits or decreasing the amount of taxes you should have paid in previous years. Additionally, receiving some non-VA benefits is potentially dependent on having a recent tax return to show a veteran meets the eligibility requirements.
There are also personal financial matters – such as securing a mortgage – where lenders or the involved institutions may need to view a tax return.
How Veterans Can Maximize Their Tax Benefits
Generally, the best way for veterans to maximize their tax benefits is through awareness. There are refundable and non-refundable tax credits and deductions that are potentially capturable on both the state and federal levels, which is why it’s wise to file tax returns even without any taxable income to report.
Special state programs – such as the aforementioned property tax benefits and other options, like reduced vehicle registration fees – may require a bit of research to find, ensuring that veterans know what’s available in their area and how to qualify. However, it’s worth digging into the topic to get access to as many benefits as possible.
Maintaining your veteran ID card is also wise. It grants access to services on military bases, including base exchanges (BXs), post exchanges (PXs), and commissaries, which are exempt from local sales tax.