Veterans: What's Taxed and What's Not on Your Federal and State Returns

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Veterans who receive a variety of special pays thanks to military service could be shielded from big federal or state tax bills, depending on whether they served all the way to retirement, received education benefits, have a service-connected disability or live in a state with special rules.

Here's what to expect on your federal taxes when it comes to several types of compensation commonly received in relation to a veteran's service, according to the U.S. Department of Veterans Affairs (VA), AARP and the Defense Finance and Accounting Service (DFAS).

Many states follow the same tax rules as the federal government, but you'll need to consult your state's tax laws -- or reach out for help -- to be sure.

VA Disability Pay

Neither the federal government nor any states tax disability payments from the U.S. Department of Veterans Affairs. The same can't be said for Social Security disability, which the federal government and some states tax above a certain income threshold. Eligibility for VA disability payments often qualifies veterans for full or partial discounts on their property taxes in their state.

Military Retirement Pay

The federal government taxes military retirement pay, but many states have exempted it partly or entirely. If you need to change your withholding amount, call the Defense Finance and Accounting Service at 800-321-1080.

Survivor Benefit Plan Premiums

While you were on active duty, Survivor Benefit Plan (SBP) coverage was free, but retirees who opt in pay monthly contributions. The government generally deducts these premiums -- never more than 6.5% of your gross retirement pay -- from your gross retirement pay on a pre-tax basis, lowering your federal taxable income. After you're gone and when a beneficiary begins receiving their annuity -- lifetime payments -- those are usually treated the same way as military retirement income.

VA Education Benefits

Payments received under any GI Bill program are tax free for veterans or any dependents or survivors who may receive the benefits. These include payments for tuition, training, testing for licenses and certifications, tutoring, work study, books and housing.

Other VA Benefits

The federal government also doesn't tax a number of other income benefits veterans may receive from the VA, including:

  • Combat-related special compensation
  • VA grants to modify a home
  • Interest from VA life insurance policies
  • VA dependent-care assistance
  • VA post-9/11 survivor benefits
  • Income received in the VA Compensated Work Therapy program

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