The Ultimate Tax Guide for Veterans

As a veteran, there are specific benefits you can take advantage of to maximize your return when you file your individual income taxes. It is extremely beneficial to identify which types of pay and compensation are exempt from taxes so you know what is excluded from your gross income on your return.

Eligibility for Veteran Tax Benefits

For tax purposes, a veteran is an individual who has served at least 24 continuous months in active duty and has not been released with “dishonorable” status upon discharge.

Active duty means you’ve served full-time as a member of the Army, Navy, Air Force, Marine Corps, Coast Guard, or as a commissioned officer of the Public Health Service, the Environmental Services Administration or the National Oceanic and Atmospheric Administration.

Who Else is Eligible?

  • Spouses of a deceased or disabled veteran
  • Children of a deceased or disabled veteran
  • Parents of a deceased or disabled veteran

6 TAX TIPS FOR VETERANS

Tip #1: Take advantage of free tax services.

There are plenty of resources that provide free tax-filing services to veterans. To narrow down your options, read about the 5 Best Free Tax Software.

Tip #2: Don’t forget about credits & deductions available to everyone.

Just like any other tax-paying individual, you may be able to take advantage of certain tax incentives. For example, if you’ve searched for a job, then in next year’s tax return you can deduct expenses for creating a résumé and cover letters, related transportation costs, and fees for phone minutes used to call prospects, hiring an employment agency, and business networking events, to name a few. Also, many disabled veterans are eligible for the Earned Income Tax Credit, which is targeted at low- to moderate-income working individuals and families.

Tip #3: Keep your records in a safe place.

To qualify for veterans’ tax benefits, you need to show evidence of your status as a U.S. veteran. Keep all your relevant documents in one place and make copies if you want to be extra safe. If you do misplace any of your important records, contact the U.S. Department of Veterans’ Affairs for replacements immediately.

Tip #4: Know your eligibility.

Don’t make assumptions about what you’re eligible for. Every benefit stipulates its own eligibility rules, some more detailed than others. For example, to receive a Specially Adapted Housing Grant, veterans must prove they are experiencing very specific physical losses or loss of use in certain body parts.

Tip #5: Track your tax liability.

Remember taxes are not withheld from military payments, so it’s important to keep track of your tax liability. According to the IRS, prior to leaving the military, you should complete Form W-4P (Withholding Certificate for Pension or Annuity Payments) to tell the Defense Finance & Accounting Service (DFAS) how much tax to withhold from your monthly retirement pay.

Tip #6: Remember tax benefits change year by year.

Check the eBenefits and U.S. Department of Veterans’ Affairs (VA) websites every year to make sure you’re taking advantage of every possible tax break.

TAX BENEFITS FOR VETERANS

There are a number of tax benefits available to veterans and their families at the federal level. Some of the most common benefits, described in more detail below, include but are not limited to:

  • Disability Pension
  • Disability Compensation
  • Education and Training Allowances
  • Dependents and Survivors
  • Life Insurance
  • Housing Grants
  • Compensated Work Therapy Program

FEDERAL TAX EXCLUSIONS FOR VETERANS

The following veterans’ benefits are not taxable. In other words, these sources do not have to be reported as income on the federal tax return.

Disability Pension

This benefit is paid to wartime veterans with limited or no income who are 65 years of age or older, or who are permanently disabled because of a non-service related incident or cause.

Veterans who are highly disabled or housebound and are receiving pension may also qualify for an additional Aid and Attendance (A&A) benefit, which is additional monetary payment available for veterans and survivors require the aid and attendance of another individual.

The additional amount from A&A may be added to the total monthly pension amount if you meet one of the following conditions:

  • You require the aid of another person for basic personal functions required for daily living, such as bathing, feeding, and dressing.
  • You are confined to your bed save the periods of time when you are being treated.
  • You are a nursing-home patient due to mental or physical incapacity.
  • Your eyesight is restricted to a corrected 5/200 visual acuity or less in both eyes, or concentric contraction of the visual field to 5 degrees or less.

The Housebound benefit can also provide an increased amount to your monthly pension if you are substantially limited to your immediate premises due to a permanent disability.

How This Affects Your Taxes
Both benefits are exempt from both federal and state income tax.

Disability Compensation

This benefit is paid to veterans who have experienced a service-connected disability. Generally, you are eligible if your disability occurred during service, was aggravated during service, or is determined by the VA as a direct result of your service.

How This Affects Your Taxes
Service-connected disability compensation is tax-free on both the federal and state levels. Disabled veterans may be eligible to claim a federal tax refund based on two situations:

  • An increase in the veteran’s disability percentage as deemed by the VA (which may include a retroactive determination).
  • The combat-disabled veteran applying for, and being granted, Combat-Related Special Compensation, after an award for Concurrent Retirement and Disability.

Education & Training

Benefits like the Post-9/11 GI Bill help finance undergraduate and graduate education for veterans.

Under the Post-9/11 GI Bill, veterans who served a total of 36 months after September 10, 2001 are eligible for financial aid. The required number of service days is reduced to 30 if you were discharged because of a service-connected disability. Reservists and National Guard members can also apply. The GI Bill benefits are based on a tiered system — the longer the service time the greater the benefits.

How This Affects Your Taxes
The financial aid from the GI Bill is not taxable and does not need to be declared as part of your income. If any other education-related income is bestowed, check taxability on a case-by-case basis.

Dependents and Survivors

The VA offers a number of benefits for surviving loved ones and dependents, including but not limited to the below:

  • Survivors may apply for the VA’s Dependency and Indemnity Compensation payment, which is a flat-rate monthly disbursement that is adjusted annually for inflation. Surviving spouses with dependent children are eligible for additional monthly payment for each child, plus an additional transitional assistance of $250 each month.
  • A survivor’s pension paid to the low-income surviving spouse and children of a deceased veteran with wartime service.
  • The death gratuity is a one-time payment of $100,000 to help surviving family members deal with the financial hardships that accompany the loss of a servicemember.

How This Affects Your Taxes
The benefits listed above are not subject to income tax. However, if you receive a survivor benefit not mentioned here, make sure to confirm tax status for each individually.

Life Insurance

The VA provides life insurance benefits to protect your family and to take into consideration the dangers of active duty in the military. Servicemembers’ Group Life Insurance (SGLI) is a low-cost group life insurance program for servicemembers.

Here are some coverages that veterans may qualify for:

  • Servicemembers’ Group Life Insurance Traumatic Injury Protection automatically provides payments to servicemembers who suffer losses, including limbs and eyesight, from traumatic injuries.
  • Service-Disabled Veterans’ Insurance provides life insurance coverage for veterans with a service-connected disability. Veterans who are completely disabled are eligible for more coverage.
  • Veterans’ Mortgage Life Insurance provides mortgage protection insurance to disabled veterans approved for a VA Specially Adapted Housing Grant.

How This Affects Your Taxes
Generally, life insurance proceeds left to a person or group do not incur income tax.

Housing Grants

The Specially Adapted Housing Grant is designed to help service-connected disabled veterans by providing a way to construct or modify a home to meet their adaptive needs, such as making a home wheelchair accessible. The current maximum of the grant is $67,555.

The SAH grant is available to certain veterans and servicemembers who are entitled to disability compensation due to any of the following:

  • The inability to use or complete loss of both lower extremities
  • Blindness in both eyes, plus the inability to use or complete loss of one lower extremity
  • The inability to use or complete loss of one lower extremity together with (1) residuals of organic disease or injury, or (2) the loss or loss of use of one upper extremity, affecting balance or propulsion as to preclude locomotion without the aid of braces, crutches, canes, or a wheelchair
  • The inability to use or complete loss of both upper extremities at or above the elbows
  • A severe burn

The Special Housing Adaptation grant is available to help improve mobility throughout the home of a veteran with a specific service-connected disability. The current maximum of this grant is $13,511.

Here is the eligibility criteria for this grant:

  • Blindness in both eyes with 20/200 visual acuity or less in the better eye with the use of a standard correcting lens
  • The inability to use or complete loss of both hands or extremities below the elbow
  • A severe burn

How This Affects Your Taxes
These grants do not have to be reported as taxable income.

Compensated Work Therapy (CWT) Program

The CWT program assists veterans who are unable to work and support themselves. Many CWT members have histories of psychiatric illness, substance abuse, and homelessness. This program provides vocational rehabilitation services tailored to the unique needs and circumstances of each individual.

How This Affects Your Taxes
Payments from CWT do not have to be reported as taxable income.

TAXABLE VETERAN BENEFITS

The three benefits listed below will require veterans to pay taxes, depending on certain exceptions. Review each of these thoroughly to understand what you are accountable for.

Retirement Pay

Service members who have been on active duty or served in the Reserves or Guard for an extended period of time, usually at least 20 years, may receive pay upon retirement. The type and amount of retirement pay depends on your age and length of service.

How This Affects Your Taxes
Usually, retirement pay is reported as taxable income. However, the following exceptions are considered tax-free income:

  • The amount a Retiree pays to participate in the Survivors Benefit Plan (SBP).
  • Military Disability Retirement Pay and Veterans’ benefits, including service-connected disability pension payments.
  • Military Disability Retirement Pay received as a pension, annuity or similar allowance for personal injury or sickness resulting from active service in the armed forces if one or more of these circumstances apply:
    • You were entitled to receive a disability payment before September 25, 1975.
    • You were a member of the active or reserve military or were under a binding written commitment to become a member on September 24, 1975.
    • You receive disability payments for a combat-related injury.

Severance

If you were injured on active duty, you can choose to receive a lump-sum disability severance payment upon discharge from the military. Note that if your disability is combat-related, you may be eligible for a monthly disability pension from the VA.

How This Affects Your Taxes
According to the U.S. Department of Veterans’ Affairs website, the lump-sum disability severance payment you received when discharged is fully taxable in the year received. However, if you are granted a VA entitlement at a later date, you may be eligible to amend your previously filed return and subtract the lump-sum disability severance payment.

Health Care

The VA provides a number of health care services, including but not limited to hospital, outpatient medical, dental, pharmacy, and prosthetic services; domiciliary, nursing home, and community-based residential care; treatment related to Military Sexual Trauma (MST); readjustment counseling; homeless veteran programs; and alcohol and drug dependency treatment. The VA supports caregivers who provide personal care services to Veterans who are seriously injured, chronically ill, disabled, or are getting older and are no longer able to adequately care for themselves.

How This Affects Your Taxes
This is a special case. Veterans are granted the option to decide whether they want to stick with their VA coverage or purchase their own health care policy through a marketplace, then get a tax credit if they qualify. However, veterans who are enrolled in VA health care will not be eligible for premium tax credits.

STATE TAX BENEFITS

This is important to keep in mind: Each state manages its own Veterans’ Affairs office and their benefits are not the same across the board. Make sure you contact your state’s VA office and inquire about any tax benefits for veterans.

Property Taxes: One of the Most Popular State Tax Benefits

Many states now reduce or eliminate property tax liability altogether for disabled veterans. For example, with California’s Disabled Veterans’ Exemption, as long as the property is the veteran’s primary place of residence; the full value of the residence does not exceed $150,000; and total household income does not exceed $40,000, a 100% disabled veteran is allowed to claim a full property tax exemption.

For more information on your state tax benefits, visit the Veterans Benefits Administration website.

THE BEST WAY TO APPLY FOR VETERANS BENEFITS

Join eBenefits.va.gov, which is a joint website of the U.S. Department of Veteran’s Affairs and the Department of Defense. The eBenefits site houses the resources and self-service capabilities for veterans all in one place.

Through eBenefits, veterans can search and apply for benefits, view their disability compensation claim status, access official military personnel documents, and register for and update direct deposit information for certain benefits, among others.

If you enjoyed reading this, sign up for free updates!

About this resource:

Created on: February 21, 2014

Updated on: May 19, 2014

Edited by: Sarah Ban, Mike Jelinek

Research by: Michael Gardon, Allen Leng, Mike Jelinek