Got a Retroactive VA Rating? You May Be Owed a Tax Refund on Your Military Retirement

Veterans go through a lot to get a VA disability rating, but a retroactive one can be especially frustrating. Proving the VA made an error about your filing date, proving your condition existed before the date you claimed, and dealing with appeals and the inevitable delay are exhausting. It’s a process that usually ends with just being relieved that it’s over. 

But this should not be the end. 

For military retirees, a retroactive award letter is more than just a retroactive rating. It can turn part of your retirement pay for which you already paid federal income tax into tax-free income. 

So, you paid taxes on the income and now it’s not taxable? That spells “refund.” And over the course of years, it can be a big one. 

The only problem is that no one is going to just mail that money to you. There’s nobody—not a robot, not an AI, and certainly not a federal employee—checking newly-issued retroactive VA award letters against veterans’ old tax returns (at least, not yet).

To get a refund on this money, you have to claim it yourself with an amended return for every year the award covers, and the clock started on the day of your new VA decision. There are a lot of veterans out there with retroactive ratings increases who do not know about this. 

Paying taxes you don’t owe is an interest-free loan to the federal government. It’s time to call in that loan.

Why is Military Retirement Pay Taxed?

I don’t know. It’s as dumb as taxing Social Security. It’s as if people get elected to Congress and immediately forget how to live real lives.

Swapping Dollar-for-Dollar 

Rated retirees basically get two checks when they leave the service. Military retired pay is taxable, and it gets reported as a pension. VA disability compensation isn't taxable.The IRS doesn’t even want to track it.

For most retirees, collecting both in full isn't automatic. In fact, for most, it’s just not gonna happen. Undercurrent federal law, a military retiree has to waive their retired pay, dollar for dollar, to receive VA disability compensation. DFAS calls this the “VA waiver” (some call it the “offset,” most of us call it “bullsh*t”).

While a retiree’s total monthly income amount doesn't change much, the important thing to know is that the swap comes when some of it moves from the taxable income column to the non-taxable one.

Because there are always exceptions, let’s talk about the two exceptions to this and how they're taxed differently:

• Concurrent Retirement and Disability Pay (or CRDP) lets retirees rated 50% or higher collect retired pay and VA compensation in full. Chapter 61 disability retirees need at least 20 years of service to qualify. DFAS will apply it automatically, and because CRDP is retired pay, it's taxable.

• Combat-Related Special Compensation (CRSC) reimburses the waived amount for disabilities your branch determines are combat-related, at any VA rating. This one has to be applied for through your branch on DD Form 2860. As disability income, this payment is non-taxable.

A retiree can't receive both CRDP and CRSC simultaneously. Eligible veterans must choose between them, and the right answer depends on the veteran’s specific ratings, pay amounts, and whether the disabilities qualify as combat-related.

For veterans whose disabilities are combat-related, CRSC can sometimes produce a larger nontaxable benefit than CRDP, but you have to know both numbers to make the right call. A tax professional can help.

How a Rating Gets Retroactive

The VA doesn't always assign a rating instantly (or even correctly) on the first go-round. Appeals take years, new evidence gets gathered, medical technology advances (yes, that’s how long it can take).

As we all know, the VA doesn't start benefits on the day it decides a claim. It starts on the effective date. If the VA gets your claim within a year of leaving active service,the effective date can be as early as the day after separation. After that first year, it's usually the date the VA received your claim or the date your condition began, whichever is later.

Meanwhile, DFAS pays retirement at the old rate while the claim works its way through the system. You paid federal tax on your retirement pay. When the rating decision finally comes through, the VA reconciles those months against the retired pay you already received.

When this happens, retirees will usually see an "amount withheld" on their award letters instead of a big back-pay deposit.

The IRS treats retirement pay from that retroactive period as excludable up to the amount of VA compensation you were entitled to, meaning you paid tax on money that, in hindsight, was never taxable. So it’s time to amend your old returns.

The Deadline

Normally, the deadline to file an amended return is three years from the date you filed a return, or two years from the date you paid the tax, whichever is later, to claim a refund. But when retired pay is reduced or waived because of a VA award, the refund deadline is extended to one year from the date of the VA's determination, no more than five years before the determination.

Say your VA decision is dated Nov. 2, 2026, with an effective date in 2019. Tax years 2019, 2020, and 2021 all began more than five years before the decision, so they're gone. Tax years 2022 through 2025 are open, and the special rule would give you until at least Nov. 2, 2027 to file.

Filing an amended return reduces the taxable income reported for that year by the amount of retirement pay that should have been excluded. Specifically, it’s the amount that would have been offset by VA disability compensation at the corrected rating.

You have to file (that is to say, mail in) a separate Form 1040-X for each year in the retroactive period. And remember to attach a copy of the official VA determination letter granting the retroactive benefit to each amended return.

Your IRS Paper Trail Checklist

• Every VA decision/award letter for the claim.
  This shows your rating, the effective date, and how the VA handled the months you were drawing retired pay. These can be printed out from VA.gov. If your rating changed partway through the retroactive period, you may have more than one.

• Your DFAS 1099-R for each affected year.
  These can be found on myPay, and they show what DFAS reported to the IRS as taxable.

• Your retiree account statements and any DFAS audit paperwork.
  Once DFAS reconciles your account, these show the VA waiver applied month by month, which is the dollar amount your refund is based on.

• Your original federal returns.
  If you pitched them, you can request transcripts through the IRS Get Transcript tool.

• Your CRSC approval letter.
  if your branch has determined any of your disabilities are combat-related.

DFAS has to audit your pay account after the VA updates compensation information, and the waiver figures may not be final until that's done. It’s always good to wait for the audit, but don't sacrifice your one-year window. If time is short, file with what you have.

That audit can also cut the other way. Retroactive changes sometimes leave retirees with an overpayment notice instead of a deposit.

If any or all of this hurts your brain, you can always go to a tax professional. 

Separated With Severance

The rules are similar for veterans who left with a lump-sum disability severance payment instead of a retirement. If the VA later awards you disability benefits, you can exclude 100% of that severance from your income. Non-disability severance and readjustment pay stay taxable, even with a later VA rating.

State Taxes Can Change

Obviously (or maybe not obviously. Call your tax guy) changing the taxable income amount on a federal return may affect your state tax liability. Fixing that is between you, your state tax office, and God. Your state returns are a separate filing with their own rules. 

Whether you're owed anything depends on where you lived during the retroactive years. Most states now fully exempt military retirement pay, but many of those breaks are new, and the years you're amending may predate them.