Taxes on Disability Payments for Veterans

Many members of our armed services that have gone to foreign wars such as Afghanistan or Iraq ended up injured. Some of these injuries are so severe that these members needed to be discharged. When a soldier is discharged due to injury, they generally receive some kind of separation compensation.

This is generally received as a lump-sum payment. In order to be eligible for the disability severance payment, the affected person must meet specific requirements:

  • Be found to be unfit for duty
  • Have had less than 20 years of service
  • Have a disability rating of less than 30%

The amount of the payment is figured by an equation. The amount equals two months of basic pay for each year of service. The minimum length of service required for computation purposes is six years in the case of an injury incurred in the line of duty in a combat zone, and three years for any other service member. The period of service cannot exceed 19 years.

Do service members have to pay taxes on this payment? “Generally, disability income from a service-related injury is non-taxable,” says George Sink, PA. However, more than 130,000 veterans may be due a refund from being taxed on their disability separation payments. Between 1991 and 2016, a period of 25 years, a computer glitch caused these veterans to have the standard 20-25% of taxes withheld. While the actual number is around 300,000 that are owed refunds, they believe many of the veterans found the error on their own.

In order to compensate the veterans who did not notice the errors, the Combat-Injured Veterans Tax Fairness Act of 2016 was passed. This act directed the secretary of defense to identify the veterans who were affected by the glitch and had taxes withheld. Letters began going out to veterans who paid the taxes on July 9th.

Generally, the Internal Revenue Service only gives taxpayers three years to claim refunds on their taxes. However, in light of the error, certain provisions have been made to allow veterans time to claim their refund.

The time frame to claim a refund is one year from the date of the Department of Defense notice to the veteran, three years after the due date for the original filing for the year the disability severance was made, or two years after the taxes were paid for the year the disability severance payment was received.

The letter sent to veterans will instruct them on how to claim their refund, but the process is basically the same for anyone filing an amended return. The affected person will need to file a federal form 1040X, Amended U.S. Individual Tax Return.

When filling out the form, affected veterans have two choices: they can include the actual amount of the disability severance payment or they can use the simplified claim, which entitles veterans to a standard refund amount as follows:

  • $1750 for tax years 1991 to 2005
  • $2400 for tax years 2006 to 2010
  • $3200 for tax years 2011 to 2016

Keep in mind that it has always been the case that a person cannot e-file an amended return. The process must be completed through the mail.

Melissa Thompson writes about a wide range of topics, revealing interesting things we didn’t know before. She is a freelance USA Today producer, and a Technorati contributor.