Over 130,000 veterans owed tax refunds after glitch

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.

"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."

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.-Arkansas -- 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.

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.

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