1. Disability Severance Pay is normally taxable income.
However, it is not subject to tax withholding or reporting if at least one of the following two conditions exist:
- As a direct result of armed conflict
- While performing in extra-hazardous service, even if the service does not directly involve combat
- Under conditions simulating war, including maneuvers or training; or
- By an instrumentality of war, such as weapons; or
2. The Service member is entitled to disability compensation as determined by the VA or has received a proposed disability rating from the VA at the time of separation through the Integrated Disability Evaluation System.
A Service member may request refund of taxes withheld from the gross taxable amount of their disability severance pay payment from DFAS if notification of disability compensation from the VA is received in the same tax year in which the member received disability severance pay.
A refund request must include documentation evidencing the VA’s award of disability compensation and must be received and processed by DFAS on or before December 31st of the year in which the disability severance pay payment was paid. If a refund is processed before December 31st, but after the Military Payroll Systems end of the year cut off (typically around December 20th), a corrected IRS Form W2c may be issued by DFAS.
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You might want to become familar with the following:
M21-1, Part III, Subpart v, Chapter 4, Section B - Recoupment of Separation Benefits
--->LINK
III.v.4.B.3.b. General Policies Regarding Withholdings to Recoup Disability Severance Pay | | Generally, if a Veteran received disability severance pay, VA must withhold from his/her monthly compensation an amount equal to the monthly compensation payable for the disability(ies) for which the Veteran received disability severance pay. VA continues to withhold this amount until it has recouped the amount specified in M21-1, Part III, Subpart v, 4.B.2.d.
Important:
- The monthly withholding may never exceed the monthly amount of compensation payable based on the initial, compensable rating, as defined in M21-1, Part III, Subpart v, 4.B.3.c, that VA assigns the severance-pay disability(ies).
- If a Veteran has multiple, severance-pay disabilities, each rated 0-percent disabling, and VA assigns a 10-percent disability rating to them under 38 CFR 3.324, no withholding is necessary for these disabilities until VA assigns a compensable rating to one or more of them, individually.
- Withhold the additional benefits payable because of application of the bilateral factor if
- the initial, compensable rating included application of the bilateral factor, and
- entitlement to the bilateral factor was based exclusively on severance-pay disabilities.
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My interpretation: If one has a zero rating from the DoD and the VA
does not award a percentage of 10% or more to the same DoD rating, then no recoupment is warranted.
If one has a zero rating from the DoD and the VA
does award a percentage of 10% or more to the same DoD rating,
then recoupment is warranted.
When in doubt, contact the VA or a veterans service officer.
Ron