Does the Strickland Decision Apply to You? How?

Apr 05 2012

Published by at 2:41 pm under Military Benefits,Taxes,VA Benefits

Mention VA retroactive awards for disability compensation and the Strickland decision will make its way into the conversation. The Strickland court decision provides tax-free status to past taxable military retired pay due to the award of retroactive VA disability compensation.

We get numerous calls on this issue, and based on my discussions, there are some misunderstandings we need to clear up.  The most common is that the Strickland decision will convert taxable retired pay…amounts above and beyond the tax-free status provided by VA compensation and Combat-Related Special Compensation (CRSC)…to tax-free status.

First, let me start the discussion about members who do not qualify for concurrent receipt. You fall in two camps: 1) retirees with at least 20 years of service, are VA rated at 40% or less and whose disabilities are not combat-related, or, 2) retirees less than 20 years, with any VA rating but your disabilities are not combat-related. You represent two-thirds of the retiree/VA rated population. Bad news is you don’t qualify for concurrent receipt; good news is the Strickland decision probably does you the most good.

By the way, your group is a priority for MOAA as we fight for your concurrent receipt benefits up on the Hill.

We all know that military retired pay is taxable income and VA disability compensation is tax-free. When you qualify for VA disability compensation, you have to agree to waive your retired pay by the same amount you receive in VA compensation; aka the VA Waiver. With the VA Waiver, you trade away your taxable retired pay to receive tax-free VA compensation. This is the foundation of whether you qualify to file amended tax returns to receive a tax refund.

Consider your retired pay situation had your retired pay been docked by the VA Waiver during the VA retro award period. The VA Waiver amount would have docked your taxable pay and you wouldn’t have paid taxes on the amount of income that was docked. You can file an amended tax return for those years to seek a refund for the taxes you paid on the income you wouldn’t have received.

You have to determine what the VA Waiver amount would have been in those years by backing-up the Cost Of Living Adjustments (COLAs) and/or VA rating changes.

Next, for those of you who are eligible for concurrent receipt in the form of Concurrent Retirement and Disability Pay (CRDP) or CRSC, the retroactive tax-free status of retired pay is a little more complex.

Retirees eligible for concurrent receipt are: 1) retirees with 20 or more years of service, VA rating of 50% or greater, or, 2) retirees regardless of years of service and regardless of your VA rating whose disabilities are combat-related.

For you, your past retired pay, after the application of the VA retro award of disability compensation, may or may not have been impacted by a VA Waiver. As discussed above, this is all about the amount of tax you paid on income you wouldn’t have paid if the VA Waiver had applied in the past.

CRDP restores your retired pay by getting rid of the VA Waiver. In restoring your retired pay, the restored portion of pay is taxable; like regular retired pay since CRDP is regular retired pay. CRDP is being phased-in over the years. By 2014, there won’t be a VA Waiver for you CRDP eligibles**. During the phase-in, your VA Waiver amount is getting smaller each year. To determine what your tax refund would be for past years, you have to know what your actual VA Waiver amount was after the application of CRDP in those past years. In other words, you can’t claim a refund for the full amount of your VA compensation because your past pay wasn’t docked for the full amount of the VA compensation due to CRDP.

CRSC impacts retirees in a completely different way than the CRDP crowd. CRSC reimburses you for all or some of the amount of your VA Waiver. All CRSC recipients have a VA Waiver in their retired pay for the full amount of their VA compensation. Because the CRSC rating and payment is based only on the combat-related nature of your disabilities and not total disabilities as is a VA rating, it is possible that your CRSC amount is less than your VA compensation.

Because CRSC is tax-free and the amount will not be more than the VA Waiver amount, the amount of CRSC is not relevant to the amended tax return affected by the retro payment of VA compensation. CRSC payees will use the VA Waiver amount to determine their tax refund status over the retro period. It is the VA Waiver amount that docks the retired pay thereby making the past retired pay income waived by the VA Waiver amount eligible for tax-free status. Your situation is similar to the folks above who aren’t qualified for concurrent receipt.

Now that you know what you are looking for in past pays, I’ll provide a few details on how to file amended tax returns.

To change past taxable retired pay into tax-free pay, you have to file a separate amended tax return (IRS Form 1040X) for each tax filing year in involved. You are filing to get a tax refund for the income you paid taxes on that should have been tax-free had the VA Waiver amount been applied during the retro period.

Some details about how to apply for the tax refund were discussed in a recent article on this blog by Curt Sheldon, one of our guest authors. See Curt’s article for his practical insights at http://moaablogs.org/financial/2012/02/va-disability-benefits-retirement-pay-and-your-taxes/.

The tax code limits the time period to file amended tax returns due to the award of retroactive VA compensation to 4 years from the time of filing the taxes being amended. So a tax filing from 2008 can be amended in 2012. See IRS Publication 525 page 17 for more details (http://www.irs.gov/pub/irs-pdf/p525.pdf).

As Curt states in his article, the burden is on you to provide the background documents to make your case when you file the amended returns. Be sure to put yourself in the shoes of the IRS official reviewing your case. Assume you know nothing about VA disability compensation, military retired pay, or retroactive VA awards. Now what paperwork would you need to convince you the amended tax return is spot on?

Best wishes. When all else fails, consult an expert tax specialist.

** Technically there could be a VA Waiver amount if your retirement pay multiplier used a greater Service disability rating rather than your years of service retired pay multiplier.

4 responses so far

4 Responses to “Does the Strickland Decision Apply to You? How?”

  1. Barbara Morganon 23 Mar 2014 at 5:39 pm

    Strickland Decision

    My husband received 100% VA Disability Decision letter in Aug 2013, retroactive to September 1012. In September 2013 he received his first payment and retroactive payment and he also received his CRSC Decision letter and payments started. Since he received the VA retroactive payment are we also eligible to change his 1099-R and not pay taxes on his retirement pay for the retroactive periods in 2012 (amended form) and 2013?

    I have searched for 2 days trying to find the answer, this article is definitely the best explanation. MOAA is the best!!!

    Barbara Morgan

  2. Shane Ostrom, CFP®on 24 Mar 2014 at 11:40 am

    Mrs. Morgan, he may be able to file an amended return if he received taxable income over the VA retro period that would have untaxed if the VA retro award been in effect in the past. The sticking point is whether his past retired pay (retro period) received CRDP or not over the retro period.

    CRDP restores the taxable retired pay normally docked by the VA retro pay. If he received CRDP for the retro period, he has little reason to file amended returns because CRDP ensured he was paid his taxable retired.

    If he had CRSC over the retro period, he has grounds for a amended tax return since he was paid taxable retired pay in the retro period and the VA retro award would negate some of that past taxable retired pay.

    I understand this gets confusing. You have to understand how CRDP and CRSC work according to the previous articles to understand why CRDP negates a amended tax filing and CRSC allows a amended return. It has to do with whether the VA Waiver is applied to your past retired pay. CRDP, no VA Waiver. CRSC, VA Waiver is applied. The VA Waiver amount determines how much of a tax refund you are eligible for. CRDP removes the VA Waiver where CRSC continues the VA Waiver.

    Bottom line, how much taxable income did you receive in the retro period that would not have been taxable with the VA retro award? Shane

  3. Retired Army WWIIon 09 May 2014 at 4:14 pm

    I am writing on behalf of my father, WWII vet, 50% VA rating, Purple Heart/Bronze Star, served 1943-1945. He has been receiving a retiree pension from DFAS tax free due to disability. He is in the VA health system. He is 96 and requires 24 care home. I just learned about CRSC as he is a Purple Heart Infanty, 50% rated receiving retiree pension I assume he is eligible. The catch is that the DFAS has told me there is no VA Waiver on file for him, so therefore he cannot apply for VA benefits, CRSC etc. If he gets VA Waiver, does his current amount go down, or does he get VA comp and the difference from the Army? If we then apply for CRSC, does he collect potentially an additional amount = the the VA Comp? I don’t want to do the wrong thing and jeoparidze the amount if money he is receiving now from Army. Also can I apply for a retro-active VA Waiver so that the CRSC would be retoractive as well? Any help is much apprciated.

  4. Shane Ostrom, CFP®on 12 May 2014 at 7:36 am

    Retired WWII–If he has no VA Waiver on file with DFAS that means he has chosen to receive Service retired pay rather than receive VA disability compensation. If he were to choose VA compensation, the amount of VA compensation would be deducted from his Service retired pay dollar for dollar; the VA Waiver is the deduction from Service retired pay (you ‘waive’ your Service retired pay to receive VA comp).

    VA comp for 50% is $825ish dollars. Subtract that from his Service retired pay. If he accepted VA comp, he would get all the VA comp tax-free and his net Service retired pay tax-free after the VA Waiver is subtracted. Does that leave any net amount of retired pay?

    CRSC is a reimbursement to replace Service retired pay docked by the VA Waiver. However, CRSC does not replace all the money docked by the VA Waiver. It only replaces the amount of money your father earned for his years of service–only 2 years.

    So, if he still has a net amount of retired pay after the VA Waiver is deducted, that net amount may be equal or be more than the CRSC would reimburse for his 2 years of service. Therefore he may qualify for CRSC but not get any additional money since the net retired pay already ensures he is paid for his 2 years of service. On the other hand, if there is no net retired pay after the VA Waiver is applied to his retired pay, CRSC would ensure he gets at least enough retired pay to ensure he is paid for his 2 years of service.

    To get an idea how much 2 years of retired pay is worth, use this formula:
    His current retired pay divided by 75% multiply by 5% = 2 years of service (roughly)

    CRSC would ensure he gets at least as much retired pay as the formula states above should the VA Waiver not leave him with at least that amount.

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