Alert Taxpayers to Errors in Reporting Income Exclusions for Disability Payments
We received many amended returns that incorrectly exclude what is properly taxable income reported on the Form 1099-R.
We are concerned about the volume of amended returns that we are receiving that reduces taxable income based upon exclusion under IRC Section 104. The IRC provides for the exclusion of income received due to personal injuries or sicknesses. Included in this exclusion are amounts for personal injuries or sickness resulting from active service in the armed forces.
Tax exempt income from the Department of Veterans Affairs (VA) is generally not reported on a Form 1099-R, box 1-gross distributions ,and therefore does not need to be calculated and excluded on the taxpayer's income tax return.
On many of the amended returns we are receiving, the taxpayer or tax representative is using the taxpayer's VA service-connected disability rating to reduce taxable income. A taxpayer's VA disability rating is the measure of the extent of a taxpayer's disability and is stated as a percentage. This percentage equals a specific dollar amount. It is not a factor to be multiplied against income to determine excludable income.
Another problem we are seeing with the amended returns and documentation provided is that the VA service-connected disability rating is not retroactive nor has the rating changed. Therefore the 1099-R issued for military retirement pay has already been reduced by any VA disability payments.
As a way for the taxpayer or tax representative to verify the accuracy of the amount reported on the 1099-R when a change has occurred they can use the Retiree Account Statements provided by Defense Finance and Account Service (DFAS) form DFAS-CL 7220/148 for the corresponding period and look under the "pay item description" section for the VA waiver amount which should correspond to your VA disability rating amount.
If you believe the current year 1099-R incorrectly reports income that should be excluded, please seek a corrected 1099-R.
In the case where the taxpayer's disability rating has been retroactively changed and corrected forms are not available, please include all supporting documentation with your filing. This documentation needs to include but is not limited to the VA's decision for service-connected compensation which specifically identifies the rating decision along with the effective dates and form DFAS-CL 7220/148 for the incorrect months before and after the change occurred.
For more information see Internal Revenue Service Publication 525, Taxable and Nontaxable Income.