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Case Study 1: Severance Pay Subject to Medical DisabilityAnita Zapata was an active member of the Armed Forces, who was separated due to a medical condition, and began receiving her military pension in February of the previous tax year. Here are the payments she reported on that year's tax return.
In the current tax year, the VA determined that she was retroactively entitled to a VA disability pension of $837 each month from the date of her discharge (February of the previous tax year). She can amend her current year tax return to exclude $9,207 ($837 x 11 months) of the pension she received. She must attach a copy of her letter of determination to the amended return. Her current tax year Form 1099-R will not include the nontaxable VA disability retirement payments received during that year. Click here for an explanation. Once the VA sends the letter of determination, all future pension payments from the government are offset by the disability percentage paid directly from the VA. Disability payments received directly from the VA are not taxable and are not included on Form W-2 or Form 1099-R. 
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