Military retirement pay from DFAS (Defense Finance and Accounting Service) is generally taxable income at the federal level — with important exceptions that reduce or eliminate the tax on certain components. Understanding which portions are taxable before you begin receiving retirement pay helps avoid under-withholding and an unexpected tax bill.

What Is Taxable

Per IRS Publication 525, military retirement pay is treated the same as any other pension or annuity income for federal income tax purposes. The full amount of your monthly retirement pay from DFAS, before any reductions for SBP premiums or other deductions, is included in your gross income and subject to federal income tax.

What Is Not Taxable

VA disability compensation is not taxable. If you receive both retirement pay and VA disability compensation, only the retirement pay portion is taxable. The VA disability amount is never included in gross income.

If you are rated as combat-related under CRSC (Combat-Related Special Compensation), those payments replace a taxable portion of your retirement pay with a tax-free benefit. The net effect is reducing your taxable retirement income dollar-for-dollar by the CRSC amount.

SBP premiums are deducted from retirement pay before tax withholding, reducing your taxable income. The amount shown on your 1099-R from DFAS reflects retirement pay after SBP premium deductions.

DFAS Tax Forms

DFAS issues a 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) to military retirees each January for the prior tax year. Box 1 shows gross distribution; Box 2a shows taxable amount (which may be less than Box 1 if you made after-tax contributions to a retirement annuity). Box 4 shows federal tax withheld.

Retirees who are also receiving CRSC payments receive a separate 1099-R showing those payments in Box 1 with a distribution code that reflects their tax-exempt status.

State Tax Treatment

Federal taxation of military retirement pay is consistent. State taxation varies significantly:

  • Several states exempt military retirement pay entirely from state income tax, including Texas (no state income tax), Florida (no state income tax), Nevada, Washington, Tennessee (investment income only), and many others
  • Several states have partial exemptions based on age or length of service
  • Some states tax military retirement pay fully as ordinary income

Per DFAS.mil, you can access the current state-by-state tax treatment chart and update your state withholding elections at mypay.dfas.mil.

Managing Withholding

DFAS withholds federal income tax from retirement pay based on the withholding certificate you file. Retirees should review their tax withholding when their filing situation changes — particularly if VA disability compensation increases (reducing taxable income), if CRSC is awarded, or if significant life changes occur. Adjust withholding via myPay at mypay.dfas.mil.

KEY TAKEAWAYS:

  • Military retirement pay from DFAS is generally taxable federal income; VA disability compensation is never taxable
  • CRSC payments replace a taxable portion of retirement pay with tax-free income, reducing your overall tax burden
  • SBP premiums reduce taxable income — your 1099-R from DFAS reflects retirement pay after SBP deductions
  • State tax treatment of military retirement pay varies widely — several states offer full exemptions
  • Manage withholding elections and access tax documents through myPay at mypay.dfas.mil