February 16, 2005
MILITARY PENSION EXEMPTION FROM STATE INCOME TAX
By: Judith Lohman, Chief Analyst
You asked (1) what the difference is between the terms “military retirement income” and “military pension” and (2) whether there are any legal barriers to exempting only military retirement pay from the state income tax while continuing to tax other types of pensions.
As you know, the Office of Legislative Research is not authorized to give legal opinions and this report should not be considered one.
There appears to be no substantive difference in the meaning of “military pension” and “military retirement income.” States use these and other terms to refer to military retirement pay in their military pension tax exemption laws. Federal law uses the term “retired pay” to refer to retirement payments to military personnel. Federal agencies commonly, though not always, use the terms “retired pay” and “military retired pay.”
Although federal law and U.S. Supreme Court rulings bar states from taxing federal and military pensions while exempting state and local pensions from state income taxes, there appears to be no prohibition against states treating military pensions more favorably than other public-sector pensions in their income tax laws. Nevertheless, only four states (Indiana, New Jersey, West Virginia, and Wisconsin) have different income tax exemptions applicable to military pensions, other federal pensions, and state and local pensions. Of the four, only Indiana treats military pensions less favorably than other federal pensions. Wisconsin is the only state that provides a tax exemption for military pension income while taxing other types of public-sector pensions fully.
There appears to be no substantive or legal difference between the terms “military pension” and “military retirement income.” Both terms seem to be layperson's descriptions of payments the federal government makes to retired military personnel.
Federal Statutes and Agencies
Federal statutes dealing with military retirement use the term “retired pay” throughout when referring to regular and disability retirement for military personnel (see e.g., 10 U.S.C.A. § 1401 – “Computation of Retired Pay”). Federal agencies generally follow suit, although the Internal Revenue Service also uses “military retirement annuities” and “military retirement pay.” (See, for example, instructions for Form 1099R, used to report “distributions from pensions, annuities, retirement, or profit-sharing plans, IRAs, insurance contracts, etc.”)
Bill Tyminski of the Defense Finance and Accounting Service (DFAS), which sends out the military retirement checks for the Defense Department, told us that DFAS uses the term “military retired pay.” Tyminski says this term encompasses the following:
● Regular retirement – payments to retirees after at least 20 years of active duty service.
● Disability retirement – payments to those injured while on active duty.
● Reserve retirement – payments to members of the National Guard and reserves who have accumulated enough service credit to retire at age 60.
“Military retired pay” does not include payments to military survivors, which are considered annuities and are payable under 10 U.S.C.A. § 1450 et seq.
Connecticut law uses the term “military retired pay” when referring to taxable military retirement income. In 2004, the state established a separate income tax withholding payment schedule that specifies deadlines for employers and other payors to remit to the Department of Revenue Services state income taxes they withhold from wages and nonpayroll amounts. In its definition of “nonpayroll amounts” subject to withholding, the law lists “military retired pay, where the payee is a resident individual and has requested that tax be deducted and withheld under this chapter” (CGS § 12-707(e)(4)(D)).
States that exempt some or all military retirement income from state income taxes use various terms for exempt income, including “pension” and “retirement income.” There appears to be no standard term used by a majority of states. For example, New Jersey exempts “military pension payments or military survivor's benefit payments” (NJSA § 54A: 6-26), while Massachusetts exempts “any income received from the United States government as retirement pay for a retired member of the Uniformed Services of the United States.” Massachusetts law also cites federal statutes to identify the payments (Mass. Gen. Laws Ann., Ch. 62 §2 (a)(2)(D)).
Federal law allows states to tax federal officers' and employees' pay and compensation for personal services (including pensions), “if the taxation does not discriminate against the officer or employee because of the source of the pay or compensation” (4 U.S.C.A. § 111). The U.S. Supreme Court has ruled that this law (1) bars a state from providing more favorable tax treatment for state and local pensions than for federal civil service pensions (Davis v. Michigan Department of the Treasury, 498 U.S. 803 (1989)) and (2) prohibits a state from taxing military pensions if it does not also tax state pensions (Barker v. Kansas, 503 U.S. 594 (1992)).
Though these rulings bar states from singling out military pensions for taxation when state and local pensions are tax-exempt, they do not bar states from singling out military pensions for a tax exemption. There appears to be no legal impediment to a state treating military retirement income more favorably than other pensions for income tax purposes.
Despite the fact that more favorable treatment of military pensions appears to be permissible, of the 35 states that exempt some or all military pension income from their state income taxes, only four do not apply identical tax exemptions to all types of public-sector pensions (military, state, local, and nonmilitary federal). The four states with differential tax treatment for public-sector and military pensions are:
1. Indiana, which exempts $2,000 of annual federal civil service pension income from state income tax while providing no exemption for state, local, and military pension income;
2. New Jersey, which exempts 100% of military pension income while providing more limited exemptions for other federal and state and local pensions;
3. West Virginia, which exempts 100% of state and local pensions for public safety retirees while capping exemptions for other state and local and federal civil service pensions at $2,000, and exemptions for military pensions at $2,000 plus an amount based on years of service; and
4. Wisconsin, which exempts 100% of military pension income while providing no exemptions for other public-sector pensions.
OLR Report 2004-R-0219 summarizes how various types of pensions and Social Security income are treated in each of the 41 states that have personal income taxes.