A reader writes:
Sir, your post on “IRS Denies Military Retirement Net Disability Exclusion” could not have been more timely. I am a retired warrant officer working for the military, and recently there was an ad in the base newspaper stating “You may be entitled to a refund from the IRS”. It had the typical pitch as you had stated. I had just submitted all the required documents for them to input the data and I just didn’t have a warm and fuzzy feeling about it. So this morning I went on the Web to conduct my own research. Lo & behold I happened to open your article which was very detailed and easy to understand. I sent the tax consultant your website and pulled my documents. I also notified several retirees (who have already processed their paperwork) to let them know about the problems that you had stated. It is now my intent to send this info to the base newspaper to see if they can run an article for veterans to be aware of this issue.
Thank you for posting this! I’ll always remember that if things sound too good to be true then more than likely they’re not true.
Case in point,
I’ve watched the search results for that post, and it’s been climbing rapidly up the rankings. In less than two weeks it’s already on Google’s first page for the phrase “net disability exclusion”, and it’s at the top of the second page for the unquoted phrase . I hope this followup post helps spread the word– again.
Here’s another link from a 2010 MOAA article by CFP Shane Ostrom that explains the issue in a different way. The net disability exclusion applies to a service-rated disability (and a disability retirement from that service). It does not apply to military retirements based on years of service for veterans who may also have a disability rating from the VA. A service-rated disability is different from a VA disability rating. They’re covered under different sections of the tax code, and the tax benefit can only be taken once.
If you have a VA disability rating then your tax benefit comes from the reduced taxable pension amount on your DFAS 1099-R. You’re only eligible to claim “net disability exclusion” benefits for your disability rating if your service retired you for a medical disability which rendered you unfit for duty.
There’s another situation where you may have to file an amended tax return. (This also adds more confusion to the issue.) If you retired from the military (based on years of service) and the VA later approved your application for a disability rating, then you’re entitled to claim that deduction on the military retirement payments you’ve already received before your VA rating was approved. You do that by filing an amended tax return for the previous years of retirement. You may also have to correct your 1099-R for the current tax year, because it takes a while for the VA to notify DFAS of your disability rating. In future tax years, the DFAS 1099-R will already reflect the VA disability rating and you won’t have to revise your numbers.
Clear? Not so much. Unfortunately it’s all in the tax code, which admittedly is a difficult read. To make this situation even more confusing, the IRS has been slow to catch up with the rising number of tax returns incorrectly claiming this exclusion. This has given the (also incorrect) impression that the exclusion was approved by the IRS. Even more unfortunately for those military retirees who have recently filed for the exclusion, the IRS is now well aware of the mistake and has programmed their computers to flag it. If you inappropriately claimed this exclusion for tax year 2011 then the IRS has probably already notified you.
Getting back to the title of this post: this is why we blog. This is why we wrote the book. We’re sharing what we’ve learned about financial independence, and we’re trying to help others avoid the pitfalls.
If your base newspaper has been running an ad for the net disability exclusion, then please let them know that I’ll be happy to talk with them about the issue. If you’re seeing this advertising on Oahu, then I’ll contact them.
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