Leaving the military comes with plenty of changes, from starting a civilian job to figuring out your next move. Your taxes may change, too, especially if you receive a final military paycheck, a leave payout, or retirement income alongside your new salary.
The good news? A little planning can help you maximize your available tax benefits and avoid an unexpected balance due. Here’s what to know about taxes after leaving the military and how to check that you’re paying enough throughout the year.
At a glance:
- Terminal leave generally continues your regular military pay and its usual tax treatment.
- Sold-back leave and military separation pay are generally taxable, with certain exceptions.
- Military retirement pay based on age or years of service is generally taxable, while Department of Veterans Affairs (VA) disability compensation is tax-free.
- Reviewing your withholding after separation can help you avoid a surprise tax bill.
How do taxes change after leaving the military?
Your first tax return after separation may include several sources of income: military wages, civilian wages, separation payments, and possibly retirement pay. You generally report these on the same federal income tax return for the year you receive them.
Your taxable income may also look different. For active-duty service members, your military compensation may include military allowances, such as Basic Allowance for Housing (BAH) and Basic Allowance for Subsistence (BAS), which are generally excluded from federal taxable income. Because a civilian salary doesn’t come with those same military exclusions, a similar compensation package could leave you with more taxable income.
Another potential issue is withholding: the money taken from your paychecks for taxes. If you receive military retirement pay and civilian wages, each payer may withhold without fully accounting for the other income, and a working spouse can add another layer.
Having taxes withheld from every payment doesn’t automatically mean you’ve paid enough overall.
Terminal leave taxes: Is terminal leave pay taxable?
Terminal leave is accrued leave you take immediately before separating or retiring from the U.S. Armed Forces. You remain on active duty during that time and continue receiving the pay and allowances you’re entitled to.
Your pay generally keeps its usual tax treatment: Basic pay is taxable unless an exclusion applies, while qualifying BAH and BAS remain tax-free. Terminal leave itself doesn’t create a special tax exemption.
What if you start a civilian job while on terminal leave?
If you begin a civilian job during terminal leave, you could receive military and civilian pay at the same time.
That overlap is a good reason to review your withholding. Your new employer won’t automatically know how much military income you’ve already earned or expect to receive.
When completing Form W-4 for your civilian job, account for your overall tax situation. The IRS Tax Withholding Estimator can help you factor in income and withholding from different sources.
Selling back leave taxes: How is unused military leave taxed?
Selling back leave means receiving a lump-sum payment for eligible unused leave. The payout is generally based on basic pay and doesn’t include BAH or BAS.
Taxable leave payouts generally have federal income tax withheld at the 22% supplemental withholding rate, plus applicable state withholding. That 22% is a withholding rate, and your final tax rate may be different. Your actual federal income tax depends on your total annual income, filing status, deductions, and credits.
Military leave sell-back payments generally aren’t subject to Social Security and Medicare taxes. Federal income tax and applicable state income tax withholding can still reduce your payout.
A federal income tax exclusion, similar to that of combat pay, may apply to payments for unused leave earned during qualifying combat-zone service. Check your leave records and final pay statement to identify qualifying leave. For commissioned officers other than commissioned warrant officers, limits apply to the exclusion, including qualifying accrued leave payments.
Terminal leave vs. selling back leave: What’s the tax difference?
| Consideration | Taking terminal leave | Selling back leave |
| Payment | Continued regular military pay | Lump-sum payment for eligible unused leave |
| Allowances | Eligible allowances continue while you remain on active duty | The leave payout itself doesn’t include BAH or BAS |
| Federal income tax withholding | Generally follows regular payroll withholding | Generally uses supplemental withholding for the taxable payout |
| Planning question | Will military pay overlap with civilian wages? | How will the lump sum affect your annual income? |
Both options can affect your transition budget. Compare the full financial picture, including your separation date and civilian job start date, rather than assuming the option with less withholding costs less in taxes.
Military separation pay taxes: How much will you owe?
Military separation pay is generally taxable and subject to federal income tax withholding, plus applicable state withholding. The amount withheld depends on the type of payment and applicable payroll rules. Check your payment statement or ask your military finance office how withholding was calculated.
Whatever the withholding amount, it’s a prepayment toward your taxes. Your final tax liability depends on your overall tax return.
Why withholding on separation pay may not cover your tax bill
Let’s say you receive $20,000 in taxable separation pay and your payment statement shows $4,400 withheld for federal income tax.
For a simplified example, assume the entire payment falls within your 24% federal income tax bracket. The federal income tax attributable to that payment would be $4,800—$400 more than the withholding. Your actual result depends on your other income, deductions, credits, and total tax payments.
If the payment instead falls within a lower bracket, the withholding could exceed the tax attributable to it.
Receiving a lump sum doesn’t mean all your income suddenly gets taxed at a higher rate. Federal income tax brackets apply progressively, with different portions of taxable income taxed at different rates.
Is military disability severance pay taxable?
An exclusion may also apply if you’re entitled to VA disability compensation or receive a proposed VA disability rating through the Integrated Disability Evaluation System at separation. Your military disability findings and VA documentation help determine the payment’s tax treatment.
If taxes were withheld from disability severance pay that qualifies for an exclusion, you may be eligible for a refund. Timing matters: The Defense Finance and Accounting Service (DFAS) directs eligible members to submit refund requests before December 15 of the year the payment was made, with supporting documentation. For prior-year payments, you generally must seek the refund through the IRS, subject to applicable filing deadlines.
Is military retirement pay taxable?
Military retirement pay based on age or years of service is generally taxable as pension income. You should receive Form 1099-R showing your retirement payments and any federal income tax withheld.
However, a VA disability payment is different, as it’s not included in federal taxable income. Certain military disability retirement payments may also qualify for an exclusion, depending on the circumstances, so you shouldn’t assume every payment you receive after retirement has the same tax treatment.
Do you use Form W-4P for military retirement withholding?
For military retired pay administered by DFAS, change your federal income tax withholding through myPay or by submitting Form W-4.
Form W-4P generally applies to periodic pension and annuity payments. DFAS uses it for annuitants, including people receiving Survivor Benefit Plan payments, rather than for military retirees’ own retired pay.
Follow the current DFAS withholding instructions. If another agency pays your retirement benefits, check its requirements.
How to coordinate retirement withholding with a civilian paycheck
Look at your retirement pay and civilian wages together when estimating your taxes. If you file jointly, include your spouse’s income, too.
For example, someone receiving $30,000 in taxable military retirement pay and $60,000 in civilian wages has $90,000 from those sources before deductions. Withholding that treats each payment stream in isolation may fall short.
You may need additional withholding from your civilian paycheck, retirement pay, or both. After making a change, review your next pay statements to confirm it took effect.
Do you owe state taxes after leaving the military?
Your state tax responsibilities depend on where you live, where you work, and the type of income you receive. States also have different rules for military pay and retirement income.
If you move or start civilian work in another state, check both states’ tax agency guidance. You may need a part-year resident return, a nonresident return, or more than one state return.
It’s important you don’t assume the state withholding arrangement you used on active duty will fit your civilian job. Review your state withholding when you start work and keep a record of your moving dates.
How to avoid a surprise tax bill after military separation
You don’t have to wait until filing season to find out whether your withholding is on track.
- Estimate your full-year income. Include military and civilian wages, taxable leave payouts, separation pay, retirement income, Thrift Savings Plan (TSP), and other taxable earnings.
- Gather your current pay statements. Use year-to-date income and withholding figures, including your spouse’s if you expect to file jointly.
- Run a withholding check. Use the IRS Tax Withholding Estimator after starting a job or receiving a significant payment.
- Update your withholding. Submit a new Form W-4 to your civilian employer if needed. For military retired pay administered by DFAS, change federal withholding through myPay or by submitting Form W-4. DFAS uses Form W-4P for annuity payments, such as Survivor Benefit Plan benefits.
- Check again when circumstances change. A raise, another job, or a change in household income can affect the result. Review withholding again at the start of the next year.
If withholding won’t cover enough of your taxes, estimated tax payments may be necessary. This can be especially relevant if you start freelancing or consulting after leaving the military.
You can usually avoid a federal underpayment penalty if you owe less than $1,000 after withholding and refundable credits or meet the applicable payment requirements. Those typically involve paying at least 90% of the current year’s tax or 100% of the prior year’s tax, whichever is less. The prior-year threshold rises to 110% if your prior-year adjusted gross income (AGI) exceeded $150,000, or $75,000 if you’re married filing separately for the current year. Payment timing also matters. Meeting a penalty exception doesn’t necessarily eliminate a balance due when you file.
What tax documents do you need after leaving the military?
As filing season approaches, gather:
- Military and civilian Forms W-2: Report wages and withholding from each employer.
- Form 1099-R: Reports military retirement payments and other applicable retirement distributions.
- Your final Leave and Earnings Statement: Helps you review final pay, deductions, and leave payments.
- Separation and disability records: Support the treatment of payments that may qualify for exclusions.
- Combat-zone leave records: Help document any qualifying exclusion for accrued leave.
- State residency information: Includes moving dates, addresses, and work locations.
Use your official tax forms to prepare your return. If a form appears to report an excluded payment as taxable, contact the payer about a correction.
FAQs about taxes after leaving the military
The bottom line
Leaving the military can change both your income and how much tax you need withheld. Understanding your final payments, checking withholding when you start civilian work, and keeping your records together can make your first tax season after separation easier.
File your tax return with TaxAct® to work through your military and civilian income and prepare your federal and applicable state returns.
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Citations
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