Certain disability pensions paid by government services are excluded from income when the disability is connected to active service. These exclusions apply to pensions, annuities, or similar allowances paid for personal injury or sickness arising from service in:
- Armed forces
- National Oceanic and Atmospheric Administration
- Public Health Service
- Foreign Service
Conditions for Exclusion
A disability pension is excluded from income if any of the following conditions apply:
- Entitled to disability payments before September 25, 1975
If the taxpayer qualified for disability payments before this date, the payments remain excludable.
- Member (or committed to become a member) on September 24, 1975
If the taxpayer was already serving or under a binding written commitment to serve in one of the listed government services or reserve components on this date, the exclusion applies.
- Disability is service‑connected
The disability must meet one of the following:
- Results directly from armed conflict
- Occurs during extra‑hazardous service
- Occurs under conditions simulating war, including training exercises
- Caused by an instrumentality of war
These are the classic combat‑related injury categories.
- Eligible for VA disability compensation
If the taxpayer would qualify for VA disability compensation upon application, the exclusion applies up to the amount the VA would pay.
Pensions Based on Years of Service
A disability pension based on years of service is generally taxable.
However:
- If the pension also qualifies as a service‑connected disability,
- Then the portion attributable to disability percentage is excluded,
- And the remainder (based on years of service) is taxable.
This split treatment is frequently tested on the EA exam.
Key EA Exam Points
- Payments for service‑connected disability are excluded.
- Payments based solely on years of service are taxable.
- If both apply, the disability portion is excluded and the service‑based portion is taxable.
- VA eligibility alone can trigger exclusion up to the VA amount.
- Combat‑related injuries include armed conflict, extra‑hazardous duty, war‑simulated training, and instrumentality‑of‑war injuries.