About once every other month or so, I get a phone call from someone that goes something like this:
"I work in the Pentagon, and I got an email that says if I'm 100% (or some other percent) disabled, 100% of my military pension is tax free. This is addressed in IRS Pub 525. I'm going to contact DFAS and stop all my withholding. What do you think?"
I then explain that that is not my interpretation of the Internal Revenue Code (IRC). We part ways and I never hear from the individual again. While I've always been confident in my interpretation of the IRC, the Tax Court just put the last nail in the coffin of this rumor.
In Valentine v Commissioner (TC Memo 2022-42), the plaintiff argued that since she had a VA disability (service connected) of 90%, she could exclude 90% of her military pension (earned for longevity) from her taxable income. The IRS disagreed. Here are the basics of the Court Case.
- Plaintiff retired from the Army in 2002 after serving for 22 years (longevity retirement)
- The year in question is 2016
- She received approximately $13,200 in VA Disability Compensation. IRS agreed that this amount was not taxable
- She also received $23,801 in retirement pay and this amount was reported on Form 1099-R
- Plaintiff only reported $3,158 of the $23,801 as taxable income. This is the point of contention as IRS did not agree
- Plaintiff claimed that VA Disability Compensation was combat related and retroactive
- She referenced IRS Pub 525 to support her position regarding the nontaxable nature of her retirement distributions
Here is what the Court Found
- The controlling portion of the IRC is IRC §104. IRC §104(a)(4) states, for any prior taxable year, gross income does not include - amounts received as a pension, annuity or similar allowance for personal injuries or sickness resulting from active service in the armed forces of any country..."
- The Court found that Ms. Valentine's VA Disability Compensation was not subject to taxation.
- That Court also found that when a retired service member receives both disability compensation from the VA and retirement distributions from his or her respective branch of the armed forces the pension payments should generally be included in income.
- The Court stated that no specific provision of IRC §104 supports the plaintiff's claim that portions of her military pension should be excluded from income.
- Finally, the Court stated that the plaintiff "misconstrues" IRS Pub 525. They also noted that IRS publications are not binding on the IRS if they conflict with the underlying law.
- Court ruled in favor of the IRS. Retirement pension income was not excludable from income due to a VA Disability Rating
There is one potential source for confusion concerning this issue. If the VA Disability is Combat Related a portion of the retirement pension can be excluded from income. But there are a couple of catches.
- You need to apply for and be approved for Combat Related Special Compensation (CRSC) by your parent service.
- You can't receive CRSC and VA Disability Compensation (CRDC) simultaneously.
Don't Get Advice on Military Financial and Tax Issues from an Email
This stuff is complicated. The email you get with something that sounds too good to be true, probably isn't true. We think you should work with a professional that deals with these issues each and every day. If you'd like to find out how we do things, use the button below to schedule a free initial consultation.