Thursday, June 2, 2011

Guest Blogger: Disability Exclusion for Military Retirees

By Monique Valentine, CPA
Monique T. Valentine CPA

As most of you know, many military retirees receive disability benefits from the Veterans Administration and receive these benefits tax-free. These benefits are in addition to the regular retirement benefits that the retiree receives from Defense Finance and Accounting Services (DFAS).

Military retirees with service-related injuries or sickness will typically apply for service-connected disability benefits from the Department of Veterans Affairs (VA) or even apply for an increase in disability benefits after an award has been granted. Once the VA receives the application for initial benefits or increased benefits, it will review the application and issue a disability rating to the retiree based on the extent of the injuries or disabilities sustained, which can take months to receive. Once a determination is made by the VA, the retiree must sign a waiver, pursuant to section 1005 of the Veterans’ Benefit Act of 1957, 38 U.S.C. 3105, agreeing to have the taxpayer’s future retirement pay reduced in an amount equal to the disability benefits to be received from the VA.  

In the meantime, during the time the application is being reviewed by the VA and before a disability rating is awarded, the retiree is continuing to receive their full monthly retirement benefits from DFAS. Once a retroactive award is made by the VA, per Revenue Ruling 78-161, based on the Strickland decision, military retirees may reduce their taxable retired pay from DFAS by the amount of the retroactive VA award for that year.  

Once the waiver has been signed by the retiree, future disability benefits will be paid to directly from the VA and the retired pay received from DFAS is reduced accordingly. Therefore, no future adjustments are necessary to the amounts received from DFAS. 

Recently, there has been some misinformation circulating in the military retiree community regarding the further reduction of military retirement benefits from DFAS based on an assigned VA disability rating. The documentation that is circulating indicates that retirees can further reduce their retirement benefits from DFAS to the full extent of their disability rating from VA, based on a memorandum issued by the Chief, Branch 2, Employee Benefits and Exempt Organizations Unit on March 31, 1999.  The information that is circulating indicates that if the retiree received a disability rating, then they can file amended returns to claim additional reductions in their taxable retired pay from DFAS based on a re-computed net disability exclusion until they reach age 65.  

Please be aware that this is not a correct interpretation of the Chief Counsel Memorandum. We have spoken with the Chief Counsel’s office and have confirmed that these claims of additional reductions in DFAS retired pay are not an accurate interpretation of the Memorandum and that the reduction in DFAS retired pay is only allowed when an initial VA award has been received or an amended award has been approved for which a retiree did not receive the benefits from the VA.


  1. Morning,

    I am trying to find out if this document is legal. It has come to the attention of the Retired Military that we can get an amendment to our taxes based on our disability. I recently filed a tax return; my preparer used The Military Disability Exclusion 26 CFR CH 1 (4-1-11 edition) 1.122-1 to justify my return. Question arise when someone saw you email on line. I want to insure that I am due this monies before I rec'd and cash the check. Thank you very much for any information you can forward.

    (804) 279-3186

  2. Russell, the tax free portion of your retirement received from the Department of Veterans Affairs is the only portion that is tax free. These payments are not reported to you on any 1099-R forms since it is tax free to you. The payments you receive from Defense Finance & Accounting Service are taxable and cannot be further reduced by any disability rating received from the Dept of VA, with one exception. That exception is if you receive a retroactive award from the Dept of Veterans Affairs. Then an adjustment needs to be made to the taxable amount received from DFAS in the year of the retroactive award.

    Monique Valentine, CPA

  3. I read this article and have found that it is flawed. Many Veterans who have retired due to Years of Service apply for VA Disability.

    While they are in limbo during this time frame, they are also receiving a retirement check from DFAS.

    The wait time from the Veterans Administration can be 6 months to 2 years or longer. When the Veteran receives an AWARD Letter from the Veterans Administration, it will show the following information.

    1. Date that the AWARD was made.
    2. Percentage of Disability.
    3. Months that pay was credited.

    CRSC information can be found at this link:

    CRDP information can be found at this link:

    DFAS will send a letter usually in December informing the Retired Veteran which program is more favorable. The Retired Veteran will need to choose CRSC (Tax free RETIREMENT) or CRDP (Taxed RETIREMENT).

    If a Veteran was awarded CRSC during the previous years of Retirement and is eligible to take CRSC, then the IRS Ruling 78-161 applies.

    DFAS will not reissue a corrected 1099R for the RETRO Amount. DFAS will only issue the Strickland Decision Letter if you REQUEST IT!

    For more information please have your CPA's read the following article at Military Officers Association of America "MOAA":

    When it comes time to file your paper version of the 1040 you will need the following documents: DD-2-14, CRSC Decision Letter, VA Disability Decision Letter (The one that has the chart on the first letter), 1099R and the Strickland Decision Letter (Call DFAS to obtain this letter).

    Be sure to include a typed letter explaining in DETAIL what you are requesting. YOU CANNOT EFILE THIS TAX FORM!!!!!

    It can be confusing for the uninitiated when it comes to Veteran Tax Issues but there are plenty of us Veterans who have the knowledge and resources to inform our accountants.

    Jim Patterson
    US Army Retired Infantry
    100% Disabled Veteran

    You may respond to this blog at the following email address:

    1. Jim, I agree with you that a retiree can apply for a refund of the retroactive benefits that are awarded which is the Strickland decision that is referenced in my article. We do this for our clients on a regular basis when they are awarded retroactive benefits. So you are correct on this point.
      The issue that I am trying to address in the article relates to retires that are treating future benefits received directly from DFAS (and not from VA as part of their disability award) as tax free, until age 65, above and beyond what the retiree receives from the VA Administration.
      Hope this helps to clarify.

    2. Hi, I'm a recently retired veteran wh just rcvd my first VA compensation payment Feb 01. I have a VA rating of 50 percent and should be receiving my retro payment in the next couple of months. My question is what part of the retro payment can be claimed on my 2012 taxes. The way I understand the system is that my VA compensation is tax free. If this is so how can I claim the retro payment for 2012. Right now every thing is as thick a mud and I can't see a thing. Any info will be appreciated. Thanks

    3. To the March 6 commenter: Where do you live? If you're a Virginia resident, our Ask a CPA Email Program can put you in touch with a CPA who can answer your question. Military tax issues are one of the focuses of the program. And it's free! Click the link below to ask your question:

      If you're not in Virginia, we should still be able to find someone to help you out.

  4. Hi I am trying to assist someone who has received the Internal Revenue Ruling 78-161 letter from the VA indicting that due to Agent Orange exposure the verteran is entitled to some form of exclusion of income reported on a 2011 1099-R. I am trying to confirm how this is calculated and can not seem to reconcile the 1099-R to the letter indicaing the total VA benefit, the previous payment, the amount withheld, the new payment and the start date. How do you reconcile the 1099-R to this letter?


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