Wouldn’t life be grand without taxes? You can’t avoid them altogether, but as an active-duty U.S. military member or a veteran, you have access to tax benefits that are mostly unavailable to other Americans. In return for your service to the country, the federal government and individual states have established tax breaks to lighten your financial load or to ease your return to civilian life.
These military service-related tax benefits fall into three groups:
Federal Income Tax Exclusions
The U.S. government lets you exclude certain types of income from your adjusted gross income calculation on your tax return. In other words, some of your income is tax-free. By completely excluding certain income, you can effectively lower the total amount of income tax you owe or increase your refund, and it may also affect the amount of any tax credit you receive.
State Income Tax Exclusions
State governments also designate certain types of income as tax-free for military members and veterans, so that these may be left out of gross income calculations. Because states differ in how they regard current military income and veterans’ benefits, refer to the tax laws in the state where you have permanent residency to understand what income may be excluded from state income tax.
Other Nontaxable State Benefits
Aside from income tax benefits, many states offer additional benefits that are nontaxable. Some states collect no property taxes, or only partial sums, on veterans’ or returning service members’ primary residences. Some other states, such as Arkansas, may waive some or all of veteran or military residents’ annual vehicle taxes or fees. Again, you’ll need to look up the specific tax laws for your state of permanent residency.
Eligibility for Veterans Tax Benefits
To take advantage of veteran tax benefits, you must first confirm your status as a veteran. You must be a veteran of the U.S. Armed Forces, which means you were an officer or enlisted personnel controlled by the Secretaries of Defense, Army, Navy, Marine Corps, Air Force or Coast Guard. Merchant Marines — U.S. civilian mariners — and American Red Cross members are not members of the Armed Forces. With some exceptions, such as hardship, you must also meet these requirements:
- You served on active duty for a minimum of 24 months.
- The minimum 24 months were continuous.
- Your discharge status was not “dishonorable.”
Federal Tax Exclusions for Veterans
The federal government assigns tax breaks to military members based on whether they are on active duty or veterans, as they typically bring in different kinds of income resulting from their respective phases in their lives and careers. This section explains tax exclusions that apply to veterans.
Military Retirement Pay
The Internal Revenue Service (IRS) views retirement pay as taxable income. If your military retirement pay is based on age or length of service, you’ll still pay income tax on it.
The upside is that military retirement pay is considered pension, not wages, so it is not considered earned income, and the government won’t collect Social Security taxes on it.
Survivors Benefit Plan
As a military retiree, you may have elected to participate in the Survivors Benefit Plan (SBP), an insurance plan that pays out monthly amounts to your beneficiaries upon your death, to prevent against financial hardship over the loss of your retirement income. If you have an SBP, you likely are paying a monthly premium that is automatically taken out of your retirement pay.
Your SBP payments are excluded from taxable income. The premium is automatically deducted from your military retirement pay before any deduction is taken for federal income tax.
Military Disability Retirement Pay
If you receive military disability retirement pay, it is excluded from taxable income and is not part of your gross income calculations. This nontaxable amount includes any annuity, pension or other service-connected disability compensation you receive as a disabled veteran.
The U.S. Department of Veterans Affairs (VA) determines whether you are a disabled veteran. Generally, you can obtain disabled veteran status with the VA if your disability is from a combat-related injury or sickness that meets any one of these requirements:
- Arose during service
- Worsened or intensified during service
- Was a direct result of your service (as determined by the VA)
What if the VA grants disabled veteran status after you have retired and after you have already paid taxes on military retirement pay based on your years of service?
Your retroactive disabled veteran status, which is based on your service-connected disability, entitles you to claim a refund on the taxes you previously paid on your military retirement pay — pay which you would have been able to exclude from income taxes based on your disabled status. Of course, to get your refund, you’ll need to file an amended return for every year you paid taxes.
Numerous other veterans’ benefits are excluded from income tax. Some of the benefits are explained in more detail further below. Here, you’ll find the IRS’s list of nontaxable benefits for veterans:
Education, training and subsistence allowances
Disability compensation and pension payments for disabilities paid to veterans or their families
Grants for homes designed for wheelchair living
Grants for motor vehicles for veterans who have lost their sight or the use of their limbs
Veterans’ insurance proceeds and dividends paid to veterans or their beneficiaries (this includes the proceeds of a veteran’s endowment policy paid before death)
Interest on insurance dividends left on deposit with the VA
Benefits under a dependent-care assistance program
Any bonus payment by a state or political subdivision because of service in a combat zone
Death gratuities to the survivors of military members who died after September 10, 2001
Housing Grant Tax Status
Have you received a VA grant to purchase or modify a home because of a disability such as blindness, severe burns or the loss of (or loss of use of) your arm, leg or lower extremities? The VA operates two housing programs — the Specially Adapted Housing (SAH) and the Special Housing Adaptation (SHA) grants — to assist veterans with qualifying disabilities. Housing grants through these programs are nontaxable.
Through these two programs, some disabled veterans with permanent and total service-connected disabilities receive grants to purchase or construct adapted homes that will enable them to live more independent lives. Disabled veterans may use the grants to modify their existing houses to accommodate their disabilities. For instance, if your disability requires you to use a wheelchair, a housing grant that allows you to purchase a house adapted for wheelchair living may be nontaxable. In certain situations, you may use the grants to pay down a mortgage loan on a house that’s already been adapted but was purchased without the VA’s financial assistance. The bottom line is that if you received grant funds from the VA to purchase an adapted home or modify your existing home to accommodate your disability, you can exclude that grant money from your income.
Compensated Work Therapy (CWT) Program
Any payments you receive from the VA’s Compensated Work Therapy Program — also referred to as Veterans Industries — are nontaxable. The CWT is a vocational rehabilitation program usually found in VA medical centers. Among its goals are opening up vocational opportunities for veterans (which includes matching veterans to competitive jobs) and assisting veterans in restoring physical and psychological functions. Veterans may receive payments through the program — such as through its Transitional Work Program — and any payments or earnings are nontaxable.
The VA offers seven varieties of life insurance, and, for the most part, VA life insurance proceeds are nontaxable. Insurance proceeds may become taxable under certain situations — for example, when proceeds are left to an estate, including the veteran’s estate. These proceeds are used in determining the value of the veteran’s estate, and it is subsequently taxed.
Interest income you receive as a result of life insurance proceeds is nontaxable. For example, if life insurance proceeds are paid to a veteran’s beneficiary in 36 equal monthly payments, the interest included in the payments is tax-exempt.
Education & Training
A military discharge usually means it’s time to assimilate into civilian life. That may involve pursuing an undergraduate or graduate degree at a college or university, or completing other relevant training for your vocation. The VA may assist in covering the cost of your education or training by providing allowances for tuition, housing and other costs. Through initiatives such as the Post-9/11 GI Bill® Yellow Ribbon Program, Montgomery GI Bill Program and the Survivors’ and Dependents’ Educational Assistance program, you or your dependent may receive an allowance. One of the advantages of such allowances is that they are tax-free.
Federal Tax Exclusions for Current Service Members
Different income tax rules apply for active-duty members. To properly pay your taxes as a current member, you’ll need to understand not only what types of pay and allowances you must include in your gross income, but also what types of items you can exclude. Keep in mind that although items may be excluded and nontaxable, the IRS may still require you to disclose them in your tax return. Current service members can separate their nontaxable items into these categories:
In-kind military benefits
Perhaps the most significant of nontaxable income for current members is combat zone pay. With the exception of officers, whose excluded amount is capped, all other members can exclude the entire amount of compensation they receive for active service while in combat zones. They can also exclude any state bonus payments they receive for serving in combat zones.
Current service members can also include other types of pay from their gross income, such as group-term life insurance, defense counseling services, professional education and disability.
Serving the country means volunteering to put your life at risk. Death is a grim reality in the military.
You do not pay tax on expenses for burial services, death gratuity payments to eligible survivors and costs for dependents’ travel to a burial site.
While you are on active duty, you receive allowances to cover some family expenses.
Those providing for certain educational expenses for your dependents and those related to family emergencies, separation and evacuation to a place of safety are all nontaxable.
You may receive living allowances during your active-duty service. Some of these allowances are nontaxable. They include: Basic Allowance for Housing (BAH), Basic Allowance for Subsistence (BAS), Overseas Housing Allowance (OHA) and the housing and cost-of-living allowances abroad that are paid for by the U.S. government or foreign government.
See the links to IRS pages in the Resources below for a complete list of living allowance exclusions.
Being on active duty means that you and your family are transplanted to different locations. Sometimes, this relocation can disrupt your life. The federal government includes moving allowances as a nontaxable item, as long as your move meets certain time and distance requirements if the move isn’t a permanent change of station. You may receive these tax-free allowances for moving household items, personal items, trailers or mobile homes. You may also receive allowances for storage, temporary lodging and related expenses, move-in housing, and military base realignment and closure benefits.
The personal use of a government-provided vehicle is not an excluded item, nor are expenses from moving furniture and other goods purchased while moving from your old home to your new home.
The federal government is cognizant of how difficult it is to be apart from family, especially your children, when you are on active duty. It includes those allowances for travel among the items excluded from taxes. Your travel allowances include: one annual round trip for dependent students, transportation for you or your dependents during a ship overhaul or inactivation, reassignment into a dependent-restricted status and leave between consecutive overseas tours. In addition, you can exclude per diem allowances.
Keep track of your travel-related expenses for reimbursement. But don’t include your travel allowances as income if you’re active military.
In-kind military benefits
Excluded items don’t always come in the form of dollar bills. Sometimes, you receive “income” through services and program participation; these are called in-kind benefits. You can exclude from your income the following in-kind benefits: dependent-care assistance programs, legal assistance, medical or dental care, commissary or exchange discounts and space-available travel on government aircraft.
The IRS considers most in-kind benefits as income except if you’re active military. See the links to IRS pages in the Resources below for a complete list of in-kind benefit exclusions.
State Tax Exclusions for Veterans
If you are fortunate enough to live in one of the seven states without a state income tax on individuals, you will only need to file your federal tax return and pay income taxes to Uncle Sam. Otherwise, for active-duty members and veterans who are residents of other states, knowing what types of income are subject to or excluded from a state’s income tax is critical. Don’t forget that even states without income taxes will impose taxes on other property, including real estate and vehicles.
Many states exempt veterans’ pensions — or military retirement pay — from their income tax. Aside from the seven states that do not have income taxes and therefore don’t tax your military retirement pay, approximately 18 other states exclude military retirement pay from taxable income. Of the remaining states, eight of them impose a limited or conditional tax. This means that the majority of states do not collect taxes on military retirement pay, so there’s a decent chance your state won’t take a bite out of your pension check.
If you’re receiving a military pension, learn what exemption your state allows for that income. See the table State Tax Benefits at a Glance on this page to learn how your state taxes your pension.
Property Tax Exemption
More than 25 states provide either partial or full exemptions of property taxes to disabled veterans. Some states that offer full exemptions from property taxes on primary residences to qualifying veterans include: Alabama, Arkansas, Hawaii, Michigan, Missouri, New Hampshire and Virginia. Many states don’t offer full exemptions but rather contingent-based exemptions restricted to veterans above a certain age or below certain income levels. Some states’ partial exemptions are limited by specified dollar amounts or by property values. For example, a disabled veteran in Georgia is eligible to receive a $60,000 exemption from tax on a primary residence. In Idaho, the disabled veteran must be at least 10 percent disabled as a result of service.
State property tax exemptions are tricky for veterans and active military. See the table State Tax Benefits at a Glance on this page to learn how your state taxes your property.
State DMV Fee Exemption
Most Americans drive cars, and states are quick to tax you for owning one. Some states will give disabled veterans a free pass from vehicle excise taxes, registration fees and other fees. Veterans may need to provide proof of disability. Your state may limit your exemption to one motor vehicle that you own and operate for personal use and not for a business. Some states may provide partial waivers of registration fees. In Connecticut, veterans are exempt from paying license and examination fees for one period, while Medal of Honor recipients and former prisoners of war receive free vehicle registration.
Here’s another instance where state rules vary widely. See the table State Tax Benefits at a Glance on this page to learn if your state waives any DMV fees for you.
College Tuition Fee Waivers
Once they are discharged from the military, many veterans find they need to go back to school to jumpstart their civilian careers. Many states offer veterans breaks on educational costs by waiving college tuition and registration fees at their state schools. Sometimes, states will waive tuition for deceased veterans’ children within defined age ranges.
Talk to a college counselor to learn if your state offers tuition or fee discounts to veterans. If the first counselor you speak to is unsure or does not know, ask another until you get a knowledgeable answer.
How Veterans Can Tap Into State Tax Benefits
Every state operates its own VA office, and it’s worth your time to seek out yours to ensure you receive the proper and most advantageous tax benefits and programs for your situation. By now you know that states offer varying veterans’ benefits, tax exemptions or waivers, and your state may offer a benefit unavailable to veterans of other states. Refer to the list of state VA offices below for contact information for your state’s office. One caveat: You may be stationed in one state temporarily but qualify for VA benefits in another state. Your VA benefits are tied to the state where you reside permanently.
State Tax Benefits at a Glance
The Best Way to Apply for Veterans’ Benefits
The first step to applying for veterans’ benefits is to register with the federal government through its self-service website, eBenefits.va.gov. This joint website of the VA and the U.S. Department of Defense provides numerous resources covering veterans’ matters.
Once you register and receive your DS Logon — a secure, self-service login ID account for accessing numerous federal government websites — you’ll be able to access records about yourself, including official military personnel documents on eBenefits.va.gov. Through this website, you also can register your direct deposit information for benefits you are eligible to receive, check your status for disability compensation claims and apply for benefits.
To properly register with the eBenefits system and obtain your official DS Logon account, you’ll need to already be enrolled in the U.S. Department of Defense’s Defense Enrollment Eligibility Reporting System (DEERS). DEERS is a computerized database containing personal and eligibility information on service members and their eligible family members. Active duty and retired service members are registered in DEERS automatically. You may find that you need to update your personal information, and you can do that on the website. If you find that you are not enrolled in DEERS, you must correct the error and update your information before you can proceed.
With your DEERS enrollment, you can obtain your DS Logon account in one of three ways:
Online through the eBenefits website.
By telephone through the VA. Call 800-827-1000 (options 7, 7, 0) and provide your Social Security number, checking or savings account number, and the dollar amount of your most recent electronic fund transfer.
In person through a VA regional office. Bring your two I-9 identity documents. Once your identity has been verified, you’ll receive an activation letter via U.S. mail within 12 business days. Use the information in this letter to activate your account online.
Take Ownership of Your Military Tax Preparation: Questions & Answers
John Eakins, through his company Military Tax Services, specializes in tax preparation for active-duty military members from all 50 states. He started his firm — which focuses exclusively on military members and their tax issues — because he continually found mistakes made by other tax preparers that were not devoted to military tax preparation on a full-time, year-round basis. Eakins discusses the tax facts that active military members must know.
What are typical issues military members face with their tax returns?
The number-one issue I’ve seen is inconsistency in tax preparation that results from different people preparing a member’s return year after year. (Military members are constantly moving from place to place.) In one year, the member is in a foreign country, so someone back home prepares it. Another year, the member has his mother-in-law prepare the return. The following year, the member prepares it himself. There’s no consistency, which often leads to problems. Different people do taxes in different ways, and you open yourself up to potential mistakes every year.
The other issue arises from state tax changes. States make changes to their tax codes. It may not happen every single year, but when it does, the state doesn’t send letters to inform members [and so members don’t know about them and don’t make adjustments to their tax preparation].
Which states are more tax-friendly to military?
Those states that don’t have any income taxes — such as Texas and Florida — obviously are more tax friendly because you don’t have to pay. Of states that do impose income taxes, there are 10, maybe 12, in which, if you’re an active military resident, the states don’t withhold any taxes. It simplifies things for these residents. Ohio and New York are on this list, so if you’re active military and a resident of New York, you get a free pass from state income taxes. Also included on the list are Michigan, Wisconsin, Kentucky and Vermont.
Which states cause the most problems for active-duty military?
In Maryland, you pay a federal, state and county tax, so you can’t e-file your return if you don’t indicate what county you’re from. Some other states also have county taxes. A lot of times you don’t find out you need to pay county tax until you go to do your return. North Carolina is another tough state, especially for married couples. For example, a service member from North Carolina makes $30,000 per year. The state of residency stays with you no matter where you are located during active duty. Suppose the service member’s spouse is from Indiana, and she has a job and maintains residency in Indiana. She makes $70,000 per year, so together you have gross income of $100,000. North Carolina will take a percentage of your [combined] gross income and then tax you based on that amount. Let’s say the percentage is 70 percent, so you’re taxed on $70,000, even though much of that amount is sourced from Indiana. You’ll still pay tax on the Indiana-sourced income. I think that’s grossly unfair, but there’s not anything I or any other software program can do about it.
What residency issues affecting taxes have you seen military members face?
Sometimes you need to go into a software program and manually change amounts and use a calculator. Take California as an example. Suppose you’re active military and deployed to a location not in California, even though you are a California resident. You are deployed for nine months on a boat and you are not in California. The state of California doesn’t withhold taxes from your paycheck during your deployment. When you return to California and do your taxes, you’ll find that every software program will look at your income based on 12 months. In California, taxes were only withheld for three months because you were deployed for the other nine months. You have to manually go into the software and calculate your tax withholding on a pro rata basis so that you pay taxes based on three months and not 12 months.
The Military Spouses Residency Relief Act (MSRRA) also creates a disconnect between what’s on paper – which is giving spouses of military members the same tax benefits as their military spouses — and what works in reality. For example, suppose the husband is from Texas, goes to California, meets someone there and marries her. He then gets transferred to North Carolina. He doesn’t have to pay North Carolina tax because he’s a resident of Texas, but his wife is still a California resident, so she would have to pay North Carolina taxes. Even more confusing is that each state has a different interpretation of the MSRRA ruling. Some states are friendlier than others. It’s a good rule but just not practical in a lot of cases.
Do you have any other advice to military members?
One thing that is always a red flag to me is when you owe income taxes to a state on your return. The military withholds taxes from your paycheck, and there should have been enough withholding to offset your state tax liability at the end of the year. That’s something I would be critical of, especially if you’re married and one of you owes money. I’ve seen members go ahead and pay it if it’s a small amount — like $87. The correct answer might have been that they were owed a $200 refund. I’m always skeptical.
The bottom line is that you need to become your own expert and take ownership. If you’re single and from Texas, which has no state income tax, then use TurboTax because you’ll probably have a very simple tax situation. But if you have a spouse with income from a different state, or you own a house or pay for day care, you may want to reach out to an expert. Ask that expert questions like, “Why is this? How does that work? What’s the benefit of this?” If you get transferred to another location, pick up where you left off. Don’t just shoot in the dark and take the expert’s word for it.
More Tax Information for Active Military & Veterans
A list of nine IRS documents focusing on federal income tax preparation for military members, including those in combat zones.
If you are in the military stationed abroad or are in a combat zone during the tax filing season, you may qualify for certain automatic extensions.
Guidance and forms that employers can use to claim the newly-expanded tax credit for hiring veterans.
GI Bill is a registered trademark of the U.S. Department of Veterans Affairs. More information about education benefits offered by VA is available at the official U.S. government Web site.