It depends on the nature of your disability. According to Publication 525, you may receive military retirement if you have a service-connected disability. If you have this disability, you need to have a VA determination letter to prove your disability status and eligibility for benefits; this letter outlines the details of your disability rating and the specific conditions considered service-connected.
If you have the VA determination letter, the portion of your pay received as a result of your disability rating is non-taxable; however, the portion received based on your years of service is taxable. The VA determination letter should state how much of your pay is taxable.
If you receive a 1099-R from DFAS then the amount reported in box 2a is taxable income. This is assuming the standard distribution code in box 7 of that 1099-R is a 7. If this is the case, your 1099R is reported correctly and you do not need to do anything because of the difference between taxable and non-taxable income is reflected in your 1099R form
Now, if you have a 1099R and boxes 1 and 2a report the same amount, you may make an adjustment to exclude the military pay that you are entitled to exclude as stated in the VA determination letter. If you do this though, make sure you have that letter in case if you are audited by the IRS. Here is how to report.
If the income is not taxable but is still reported on the 1099-R form, you can enter a deduction in the "Other Income" line on your form 1040.
1. Find the "Income and Expenses" menu option in TurboTax
2. Find "Less Common Income" and then "Miscellaneous Income, form 1099-A, 1099-C and edit that entry
3. On the next screen click on "Other Reportable Income"
4. You will find an option to type in a description of your adjustment and you will enter your exempt income as a negative amount represented by a minus in front of the amount to be excluded. Give it a description such as Service connected disability allowed by VA determination letter and then the amount with a minus sign in front of it.
Thus, the income will go in as pension income and then be cancelled out by an equal negative adjustment on your 1040.
One final note, you may be audited if you send in the return electronically. I suggest sending the return by mail and then attach a statement stating why you made the negative adjustment. you may also attach the VA determination letter as further proof.
@careybaylor78
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