By William L. Stunkel, CPA
Were you given disability severance pay when you left the military? This is not the opening line of a late-night infomercial: if you did receive disability severance pay, you may in fact find that you are due money back from the IRS.
The Combat-Injured Veterans Tax Fairness Act of 2016 (CIVTF Act) entitles certain U.S. veterans to file for a refund of income taxes they might have paid on their disability severance pay. In the past, the Defense Finance and Accounting Service (DFAS) reported these payments on Form W-2 as taxable income, and withheld income taxes on those payments. Typically, a taxpayer can only amend a return for a refund if a return was filed within the past three years. The CIVTF Act allows eligible veterans to apply for a refund for years that may go as far back as 1991.
Many taxpayers do not keep records that go back that far (most professionals advise keeping such financial records for seven to 10 years), so the IRS and DFAS jointly sent out about 130,000 letters to discharged military members. These military members received disability severance pay that was reported as taxable income and had federal income tax withholding taken from the payment. As such, these individuals likely reported the payment as taxable income on their respective income tax filings; thus, they reported a tax liability that was higher than what it should have been.
To qualify under the CIVTF Act, your specific circumstances must meet the following:
- You have a combat-related injury or illness as determined by your military service at separation that …
-- Resulted directly from armed conflict, or
-- Took place while you were engaged in extra-hazardous service, or
-- Took place under conditions simulating war, including training exercises such as maneuvers, or
-- Was caused by an instrumentality of war
- You are receiving Veterans Affairs (VA) disability compensation or you have received notification from the VA approving such compensation.
If you received a joint letter from IRS/DFAS regarding this claim, you are considered to have received a qualifying disability severance payment. You have two options for obtaining a refund of the income taxes you likely paid:
- File an amended return based on the actual difference between your return as filed and what should have actually been considered taxable using Form 1040X.
- File an amended return using a standard refund amount ($1,750 for tax years 1991 to 2005, $2,400 for tax years 2006 to 2010, or $3,200 for tax years 2011 to 2016).
If you did not receive a joint letter from IRS/DFAS regarding eligibility for this claim, but feel you may be eligible, you can file an amended return using Form 1040X. However, you must include the following information to verify your eligibility:
- A copy of documentation showing the exact amount of, and reason for, the disability severance payment, such as a letter from the DFAS explaining the severance payment at the time of the payment or a Form DD-214.
- A copy of either the VA determination letter confirming the veteran's disability or a determination that the veteran's injury or sickness was either:
-- Incurred as a direct result of armed conflict, or
-- While in extra-hazardous service, or
-- In simulated war exercises, or
-- Was caused by an instrumentality of war
It may be beneficial to try to determine the amount of a refund if filing an amended return using Form 1040X for the actual difference of the year in question. This is because removing the disability severance payment from taxable income may affect other deductions or credits that you were or were not previously eligible for when treating the payment as taxable income.
If it is in your favor to claim the standard refund amount (i.e., the refund after calculating the actual difference is lower than the standard refund amount), then you can simply claim the standard refund amount.
Additional information can be found at the IRS website as well as the DFAS website.
If you have received such a letter and would like filing assistance, use PICPA’s CPA Locator tool to locate a professional who will help you determine what refund you are entitled to.
William L. Stunkel, CPA, is director of small business services with Holsinger PC in Wexford, Pa. and is a member of PICPA’s CPA Image Enhancement Committee. He can be reached at firstname.lastname@example.org