Most disability pensions received from the VA aren't considered earned income, and aren't taxable benefits. The IRS applies this exclusion to benefits received for service in any country's armed forces as well as the public health service. Disability pensions calculated on a basis of years of service in an organization are taxable, but only the amount that exceeds the amount of disability benefits a taxpayer would receive from the VA based upon the level of disability. For example, a former soldier who receives $7,000 annually in service-calculated disability benefits and would be eligible for $6,000 in benefits from the VA must claim $1,000 as income.
Non-Service Connected Pension
Troops who served in federally recognized periods of war and suffer from a 100 percent disability may also receive a non-service connected pension, which is also known as an improvised pension. This amount, which the VA provides only to those with extreme financial need, qualifies as earned income. Beneficiaries who receive improvised pension amounts must report them as income and pay income taxes upon them accordingly. Veterans who receive these benefits receive a W-2 that reports benefit information. These amounts should be reported on Form 1040, Line 7.
Don't confuse your VA disability benefit with your military pension. All three pension plans -- final pay, high-three and CSB/Redux -- are different from VA disability benefits, and the IRS classifies these as earned income. The annual amount earned through pensions must be claimed on Form 1040, Line 16. Veterans who receive disability benefits from the VA as well as military retirement benefits need only report the amount of their retirement benefit as income.
Other VA Benefits
While the IRS exempts Veterans Administration's disability benefits from earned income reporting, some of the administration's other benefits aren't exempt from taxation. Veterans or their dependents who receive educational assistance from the VA may be required to report the benefit amount each year, and certain survivor's benefits may be taxable, depending upon the survivor's dependents and other tax status. VA disability beneficiaries who receive other forms of benefits must consider each one's taxable status when filing income taxes, as they aren't covered by the same exemptions as disability benefits.