Over 130,000 injured vets owed big tax refunds, due to government computer glitch

In this photo taken Friday, April 21, 2017 paratroopers with the 82nd Airborne Division's 3rd Brigade Combat Team participate in a training exercise at Fort Bragg, N.C.
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More than 130,000 U.S. veterans who were released from service due to injuries sustained in combat are due substantial federal income tax refunds because of a Department of Defense error that stretched on for decades.

For 25 years, between 1991 and 2016, a computer glitch at the agency caused non-taxable disability severance payments to be subject to income taxes, a Defense Department official told CBS MoneyWatch. The government is now trying to help veterans or their survivors recover these old overpayments, each of which is expected to result in refunds of $1,750 or more.

For vets who may be due a refund, the compensation process is likely to be complicated given that many taxpayers not have saved decades-old tax records. However, it is well worth the effort. The National Veterans Legal Services Program (NVLSP), a nonprofit advocacy group that originally discovered the tax mistake, estimates that some veterans are due refunds exceeding $10,000.

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"I would encourage veterans and surviving family members to contact a Veterans Service Officer to help navigate the process," said Doug Nordman, a retired military officer who now writes The Military Guide blog. "Every case is going to be different."

Where are these refunds coming from, and how can vets claim them?

Disability payments made to combat-injured veterans are supposed to be tax-free. The problem occurred when the Defense Department's automated payment system failed to differentiate disability severance payments from taxable income from 1991 to 2016.

As a result, the agency withheld its standard 20-25 percent from pay, and some 300,000 combat-injured servicemen and women released from service during that 25-year period unknowingly overpaid their taxes. Some of these veterans are believed to have spotted and corrected the error on their own. However, many had no idea that they had overpaid. The government believes more than 130,000 have yet to claim refunds.

U. S. tax law typically bars taxpayers from filing refund claims more than three years past the tax return filing date. But after discovering the error, the National Veterans Legal Services Program felt the mistake was so egregious that it was set to file a lawsuit against the government for not flagging and fixing the mistake.

Instead, two U.S. senators -- Sen. Mark Warner, D.-Virigina, and Sen. John Boozman, R-Arizona. -- in 2016 sponsored legislation to allow all affected veterans to claim refunds – regardless of the statute of limitations – eliminating the need to sue. That law, the "Combat-Injured Veterans Tax Fairness Act," passed and went into effect at the beginning of 2017. It has taken the Defense Department until now to determine which veterans were affected by the tax issue and how much each vet overpaid.

How would I know if I am due a refund?

Many veterans (or their deceased spouse/relative) who got a disability discharge between January 1991 and the end of 2016, and also received a disability severance payment from the Defense Department, are likely to be affected. (Regular monthly disability income payments made by the U.S. Department of Veterans Affairs are apparently not impacted.)

If vets received one of these severance payments and didn't already file a refund claim, they should receive a letter in the mail from the Defense Department explaining how much income they received that was subject to improper taxation. They have one year from the receipt of that letter to file an amended tax return and claim their refund.

When should I expect that letter?

The Defense Department started sending these letters on July 9 and expects to continue the notifications through July 20.

What if I don't get a letter?

If vets believe they're due a refund but don't receive official notification, they may still file an amended tax return and claim it. The process is just more difficult.

How do I make a claim?

If veterans got a letter, there are two options. They can follow the instructions to fill out a full form 1040X (amended return) using the amount of improperly taxed income in the DoD letter. There is also a simplified default method, which requires that they merely write "Disability Severance Payment" on line 15 of the 1040X form and claim a standard refund amount that is based on the year that they received a severance payment.

The default refund amount is:

  • $1,750 for tax years 1991 through 2005
  • $2,400 for tax years 2006 through 2010
  • $3,200 for tax years 2011 through 2016

What's the best method to use?

The default method is the simplest, but it could result in a lower payout if service people were in the military for a long time or were higher-ranking officers.

Why?

Because the improperly taxed lump-sum disability severance payments were based on a formula that multiples two months of base pay by every year of service. For example, if a vet's base pay was $1,000 per month and he or she was in the service for five years ending in 1991, the person would've paid tax on an additional $10,000 in income ($1,000 x 2 x 5). Assuming a 25 percent tax rate,a vet would've overpaid by $2,500. In this case, the default payment would offer $750 less than due.

However, if you had the same base pay but were in the service for just three years ending in 1991, you would have overpaid on just $6,000 -- resulting in $1,500 of overpaid tax. In that case, the default method for claiming a refund would be the best deal.

Experts expect the Defense letters to provide details on the amount of income on which affected veterans were improperly taxed, which should make the determination of which method to use simpler.

If I want to file a full 1040X to get the better refund, do I need to have a copy of the appropriate year's tax return?

Yes. If you don't have it (understandable), you can request it from the IRS. But realize that even the IRS has a limit on how long it maintains old tax returns. If the relevant tax return is more than seven years old, vets may have to reconstruct it as best they can.

"We certainly hope there is going to be a lesser standard of proof applied to these cases, but we don't yet know," said David Sonenshine, senior staff attorney with the National Veterans Legal Services Program.

IRS officials could not say Thursday whether normal standards of proof would be waived with these returns. All Disability Severance claims should be sent to:

Internal Revenue Service
333 W. Pershing Street, Stop 6503, P5
Kansas City, MO 64108

What if the service member is deceased?

If a deceased vet's surviving spouse filed a joint return for the relevant year, he or she can use the same 1040X procedure as everyone else. However, if you are a court-appointed representative or trustee filing on behalf of the estate, you will need to file an additional form – Form 1310 (Statement of Person Claiming a Refund Due to a Deceased Taxpayer) -- as well.

What if I'm due a refund but don't get a notification letter from the Defense Department?

Vets may still file a refund claim, but they will need a copy of the form DD-214 or a letter from the Defense Finance and Accounting Services explaining the severance payment. They will also require a copy of the VA disability determination letter that specified that the service member's injury or illness was incurred as a direct result of armed conflict while in extra-hazardous service, or in simulated war exercises, or caused by an instrument of war. Don't have those? Contact theDefense Finance and Account Services to get the necessary proof.

Confused?

The Defense Department recognizes that the process for claiming a refund is complex, and is in the process of compiling a list of resources to provide help for former service members. This list is expected to be provided to the media on Monday. The NVLSP is also standing by to help. You can reach this organization by email at info@NVLSP.org.