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Tax guide for veterans: How to maximize your return
As a veteran, you can take advantage of specific benefits to maximize your return when you file your income taxes. By identifying which types of pay and compensation are exempt from taxes, you'll 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 was not released with "dishonorable" status upon discharge. However, if you enlisted before September 8, 1980, no minimum length of service is necessary to be considered a veteran.
"Active duty" or "active services" 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.
It's important to note that a veteran is a former member of the armed forces who has been discharged, whereas someone on active duty is still an active member of the armed forces. Each distinction works differently for tax purposes.
Who else is eligible for veteran benefits?
In addition to veterans themselves, family members may be entitled to benefits. Qualifying family members may include:
- Spouses
- Children
- Parents
Per the VA.gov website, not all family members are eligible for all veteran benefits, and some benefits are only available in certain circumstances.
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. Some of the best tax software on the market also include tools to help veterans claim eligible tax benefits. The IRS website also links to several tax services that veterans and other taxpayers can take advantage of. As a veteran, you may qualify for free financial coaching. You may also qualify for free tax preparation services through The Volunteer Income Tax Assistance (VITA) program, and you can file income taxes for free through the IRS website using their free tax filing 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, you can deduct expenses in next year's tax return for things such as 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 veteran tax benefits, you need to show evidence of your status as a US veteran. The best way to do this is with a Veteran ID Card (VIC). According to the VA website, you can apply for a VIC online, but you'll need the following documentation:
- Your Social Security Number (SSN)
- A digital copy of form DD214, DD257 or NGB22, which you can upload as a .pdf, .jpeg or .png file
- A copy of a current and valid government-issued ID
- A digital color photo of yourself from the shoulders up
If you need to, you can also send a request for military service records through the usa.gov website. Per the website, "military records help prove military service when applying for jobs or government benefits." Keep in mind that extremely old and very recent records may not be in the archives.
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 US 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 aren't 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.
Tax benefits for veterans
There are several tax benefits available to veterans and their families at the federal level. Some of the most common benefits are described in more detail below and include, but aren't limited to:
- Disability pension
- Disability compensation
- Education and training allowances
- Dependents and survivors
- Life insurance
- Housing grants
- A compensated work therapy program
Federal tax exclusions for veterans
The following veterans' benefits aren't taxable. In other words, these sources do not have to be reported as income on the federal tax return.
Disability pension
This benefit is administered by the VA and 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.
To qualify for a disability pension, you must:
- Have at least 90 days of active duty, including one day during a wartime period
- Age 65 or older with limited or no income, or
- Totally and permanently disabled, or
- A patient in a nursing home receiving skilled nursing care, or
- Receiving Social Security Disability Insurance, or
- Receiving Supplemental Security Income
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 an additional monetary payment available for veterans and survivors who require the aid and attendance of another individual. Housebound individuals are unable to leave their homes without assistance due to illness or age.
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 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 the disability pension benefit and the Aid & Assistance benefit are exempt from both federal and state income taxes. This means they are not counted as part of your income for tax purposes.
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.
The VA keeps an extensive list of health conditions that may qualify as disabilities. Service-connected disabilities may include, but are not limited to:
- Hearing loss
- Eye conditions and blindness
- Post-Traumatic Stress Disorder (PTSD)
- Anxiety, depression, and other mental disabilities
- Loss of extremities (limbs)
- Limitation of motion
- Paralysis
- Muscle injuries
The VA uses a rating system to determine the severity of a disability and the number of benefits to be provided to the veteran.
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.
Your "service-connected" disability payments can vary depending on the rating the VA applies to your disability.
Education and training
Benefits such as the Post-9/11 GI Bill help finance undergraduate and graduate education or on-the-job training for eligible veterans. You may qualify for the Post-9/11 GI Bill if:
- You have at least 90 days of aggregate active duty service after Sept. 10, 2001, and are still on active duty
or
- You are an honorably discharged veteran
or
- You were discharged with a service-connected disability after 30 days.
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.
Children and spouses of active military members may benefit from GI Bill benefits, but only if some or all of those benefits are transferred to them while the service member is still serving as an active member of the armed forces.
How this affects your taxes
The financial aid from the GI Bill is not taxable and doesn't 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. If you transfer your GI Bill benefits to a spouse or child, it is still not considered taxable income.
Dependents and survivors
The VA offers several benefits for surviving loved ones and dependents, including but not limited to the below:
- Spouses, dependent children, surviving spouses, and surviving children may qualify for healthcare benefits through the CHAMPVA program, the Department of Defense's TRICARE program, or other programs. Healthcare benefits must be declared during the tax filing season, but because this benefit is not direct income, it isn't taxed.
- Spouses, dependent children, surviving spouses, and surviving children may qualify for education and training benefits, including the Survivors' and Dependents' Education Assistance Program. This education benefit is tax-exempt.
- 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 payments for each child, plus additional transitional assistance of $250 each month. This is a tax-free benefit.
- A survivor's pension may be paid to the low-income surviving spouse and children of a deceased veteran with wartime service. This is a tax-free benefit.
- 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. This benefit is free from both federal and state income taxes.
- Other benefits include home loan programs, life insurance options, and burial benefits.
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 individually confirm tax status for each.
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 service members who suffer losses, including limbs and eyesight, from traumatic injuries.
- Service-Disabled Veterans' Life 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
Certain disabled service members and veterans may qualify for adapted housing grants.
The Specially Adapted Housing (SAH) 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 maximum dollar amount allowable for these grants during the 2022 fiscal year is $101,754. You may use the grant benefit no more than three times up to the maximum dollar amount allowable.
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 loss, or loss of use of one or more lower extremities due to service on or after September 11, 2001, which so affects the functions of balance or propulsion as to preclude ambulating without the aid of braces, crutches, canes, or a wheelchair (limited to 30 recipients per fiscal year).
The Special Housing Adaptation (SHA) grant is available to help improve mobility throughout the home of a veteran with a specific service-connected disability. The maximum dollar amount allowable for these grants during the 2022 fiscal year is $20,387. As with the SAH grant, you may use the SHA grant benefit no more than three times up to the maximum dollar amount allowable.
Here are 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 don't need 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 with 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 time, usually at least 20 years, may receive pay upon retirement. The type and amount of retirement pay depend on your age and length of service.
How this affects your taxes
Retirement pay is usually 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 VA 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 several 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.
- 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 its benefits aren't the same across the board. Make sure you contact your state's VA office and inquire about any tax benefits for veterans.
Some of the most popular state tax benefits for veterans include the following:
Property tax exemptions
Many states now reduce or eliminate property tax liability for disabled veterans. For example, California's Disabled Veterans' Exemption provides a basic $100,000 exemption or a low-income exemption of $150,000 available to any disabled veteran who:
- Is blind in both eyes; or
- Has lost the use of two or more limbs; or
- Has been determined disabled by the VA or by the military service that discharged them
Almost every state has some type of property tax exemption for veterans, including the District of Columbia (Washington, DC).
In Kansas, disabled veterans can claim a "Homestead Refund" that is quantified by the severity of their disability. Surviving spouses can also claim this refund.
Income tax exemptions
Some states provide veterans with income tax exemptions. For example, in New Jersey, veterans who were honorably discharged can claim an income tax exemption of $6,000. This applies to any veteran who was honorably discharged or released under honorable circumstances from active duty in the armed forces of the United States on or any time before the last day of the tax year.
Retirement pay exemptions
As of January 2020, a total of 31 states don't tax retired military pay. Indiana and North Dakota recently joined the list. Some of these states fully exempt military retirement pay from taxes while others provide some type of exemption for military retirees.
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, register for or update direct deposit information for certain benefits, and more resources.
[This article was originally published on The Simple Dollar in March, 2020. It was updated in November, 2021.]