When retirement pay is based on years of service, the portion of it equal to the amount the person would get if retired pay were computed solely on the basis of disability is tax-exempt. The balance is taxable. VA Compensation a. Payment received from VA is tax-exempt, but mere entitlement to the payment will not result in any tax saving until a formal waiver of equivalent retired pay has been executed. Therefore, there would be no tax advantage effected by waiving military retired pay unless VA compensation exceeded the portion of the retired pay based on disability. State Taxation of Retired Pay a.
Some States exempt all or a portion of retired pay from income taxation.
Some States exempt disability retired pay in the same manner as the Federal Government. In all States, disability payments received from VA and all Social Security payments are exempt from taxation. Few States, if any, permit a retirement income credit of the type granted by the Federal Government. Retirees who do not currently have state tax withheld from retired pay but would like to may request it from DFAS-IN by a letter over their signature and social security number. The letter must state the amount of tax to be withheld and the state to which it will be paid.