If you're a veteran who received a disability severance payment between 1991 and 2016, you could be owed a hefty tax refund.
During that time period, the Department of Defense (DOD) withheld taxes on disability severance payments that should not have been taxed. After that issue was brought to light, Congress passed the Combat-Injured Veterans Tax Fairness Act of 2016, which instructed the DOD to make good and notify those who are owed money.
The Defense Department is now trying to help veterans (or their survivors) recover these old over-payments, each of which is expected to result in refunds of $1,750 or more and began sending the notices on July 9 and expects to continue through July 20.
According to the National Veterans Legal Services Program,
the government owes veterans a collective $78 million
The organization said on social media that it is in the process of working with a law firm to compile a guide of tax advice for impacted veterans.
If you believe you're due a refund but don't receive official notification, you may still file an amended tax return and claim it, but the process is just more difficult. You will need a copy of the form DD-214 or a letter from the Defense Finance and Accounting Services explaining the severance payment as well as a copy of the VA disability determination letter that specified that the service member's injury or illness was incurred as a direct result of armed conflict while in extra-hazardous service, or in simulated war exercises, or caused by an instrument of war. If you don't have those, contact the Defense Finance and Account Services to get the necessary proof.
Those impacted can file a claim for the actual amount they paid or opt to claim a standard refund of up to $3,200 depending on when they received their severance payment, according to the IRS.
Though the statute of limitations for filing a 1040X is generally three years from the original filing date, the Combat-Injured Veterans Tax Fairness Act affords veterans one year from when they receive the DOD's letter to file their return(s).
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What if the service member is deceased?
If a deceased vet's surviving spouse filed a joint return for the relevant year, he or she can use the same 1040X procedure as everyone else. However, if you are a court-appointed representative or trustee filing on behalf of the estate, you will also need to file form 1310, Statement of Person Claiming a Refund Due to a Deceased Taxpayer.
How do you make a claim?
If you receive a letter, there are two options.
File a full form 1040X using the amount of actual amount of their disability severance payment that was improperly taxed as income.
Use the simplified default method, which requires that they merely write "Disability Severance Payment" on line 15 of the 1040X form and claim a standard refund amount that is based on the year that you received a severance payment.
The standard refund amounts are:
- $1,750 for tax years 1991 through 2005
- $2,400 for tax years 2006 through 2010
- $3,200 for tax years 2011 through 2016
What's the best method to use?
The standard refund is the simplest, but it could result in a lower payout if service people were in the military for a long time or were higher-ranking officers because the improperly taxed lump-sum disability severance payments were based on a formula that multiples two months of base pay by every year of service.
For example, if a vet's base pay was $1,000 per month and he or she was in the service for five years ending in 1991, the person would've paid tax on an additional $10,000 in income ($1,000 x 2 x 5). Assuming a 25 percent tax rate, a vet would've overpaid by $2,500. In this case, the default payment would offer $750 less than due.
However, if you had the same base pay but were in the service for just three years ending in 1991, you would have overpaid on just $6,000 -- resulting in $1,500 of overpaid tax. In that case, the standard refund method for claiming a refund would be the best deal.
If I want to file a full 1040X to get the better refund, do I need to have a copy of the appropriate year's tax return?
Yes. If you don't have it, you can request it from the IRS. But realize that even the IRS has a limit on how long it maintains old tax returns. If the relevant tax return is more than seven years old, vets may have to reconstruct it as best they can.
All Disability Severance claims should be sent to:
Internal Revenue Service
333 W. Pershing Street, Stop 6503, P5
Kansas City, MO 64108
More information from the IRS can be found here.
The Defense Department recognizes that the process for claiming a refund is complex and is in the process of compiling a list of resources to provide help for former service members.
The NVLSP is also standing by to help. You can reach this organization by email at info@NVLSP.org.
While we are, of course, available to provide you with any business, accounting or tax services, the information contained herein is general in nature; any advice regarding those services should not be construed as tax advice and is not intended as a thorough, in-depth analysis of specific issues, a substitute for a legal, accounting or tax advice or opinion, nor is it sufficient to avoid tax-related penalties to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact Strive Tax & Accounting, LLC or other tax professional prior to taking any action based upon this information. Strive Tax & Accounting, LLC assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.