Defense Has Wrongly Taxed Disabled Combat Vets For Years

Veterans who had to medically retire from the military because of combat-related injuries during the last two decades have lost out on thousands of dollars in severance pay because the Defense Department improperly taxed those payments.

It’s unclear how many veterans have been affected, but the nonprofit National Veterans Legal Services Program estimated it could be close to 14,000 vets who were wrongfully taxed, going back as far as 1991, for a total of $78 million in lost compensation. NVLSP, along with Republican Sen. John Boozman of Arkansas and Democratic Sen. Mark Warner of Virginia, are working now to pass legislation requiring Defense to fix the problem, and reimburse all those affected.

Since 1991, federal law has stipulated that the government is not supposed to withhold taxes from the one-time lump sum disability severance pay given to veterans forced to leave the service because of combat-related injuries. But that’s what has happened, costing vets on average roughly $5,000 in lost pay, according to NVLSP estimates. The amount of lost compensation, though, could vary widely among individual vets, depending on the amount of the lump sum received, said Thomas Moore, project manager for NVLSP’s Lawyers Serving Warriors initiative. NVLSP uncovered the decades-old, systemic problem during an unrelated review of some combat-injured vets’ financial documents, which revealed the discrepancy.

Defense has known about the problem for years, but has yet to come up with a comprehensive solution that prevents it from happening in the first place. Basically, it’s up to veterans to figure it out for themselves and recoup the money. They can either request a direct tax refund from the Defense Finance and Accounting Service, if it occurs during the same tax year as their separation, or file an amended tax return with the Internal Revenue Service if the disbursement is within the three-year statute of limitations for filing amended tax returns.

The onus should not be on the veteran to unwind and correct the mistake, Moore said. “It should have never been an issue to begin with. They should been paid their full amount without jumping through hoops.”

The accounting error related to taxes and disability severance payments might stem from the system’s shortcomings when identifying DSP categories. While combat-injured vets receiving DSP aren’t supposed to be taxed on that payment, the government does withhold taxes on disability severance payments for service members who are separated because of non-combat-related injuries.

“Going forward, the department is working on a process to allow tax withholding decisions to be made with respect to the second group of members based on information available prior to separation,” said DoD spokesman Matthew Allen, over email. “In addition, the department is working on improving the process to ensure that members separated for combat-related disabilities do not have taxes withheld from their separation pay. When implemented, these process changes should greatly reduce the risk of tax withholding errors.”

Defense also doesn’t know how many veterans were improperly taxed but “does not believe the problem is as widespread as recent reports might suggest,” Allen said.

The 2016 Combat-Injured Veterans Tax Fairness Act will require the department to identify affected veterans, notify them, and ensure the government pays them back. It also extends the statute of limitations on amended tax returns for affected veterans so that “those who were wronged long ago can still receive their full and proper payments,” Warner said.

Between 10,000 and 11,000 service members are medically retired from duty each year, and that group includes those separated because of combat-related injuries. “DoD has unjustly withheld taxes despite clearly-written federal law and a court opinion to the contrary,” said Boozman. “We have a responsibility to right this wrong and ensure that our nation’s wounded veterans receive the benefits they are rightfully due.”

Allen said that the Defense Department “does its best to uphold its legal obligations to withhold taxes for the Treasury absent clear evidence that the payments are not subject to income tax.”

Brandon Davis, an Army veteran discharged in 2005 because of combat-related injuries he suffered while serving in Iraq, lost $8,000 because Defense mistakenly taxed his disability severance pay. “I recall hearing that there was a computer problem related to disability severance payments, but no one ever explained what I needed to do to recover the money that was taken from me,” said Davis, who lives in Arkansas and supports the Boozman-Warner bill. “This money would have helped me and my family as we adjusted to life after being discharged from the military. Because 11 years have passed since the money was taken, now I have no way to get it back unless this legislation is passed.”