The Internal Revenue Service (IRS) has announced that tax relief is available - retroactively - for veterans who received disability severance pay after January 17, 1991, and included that amount as income on their taxes. Approximately 130,000 separated military members who received disability severance pay as income may be affected.

Typically, Disability Severance Pay is not taxable or subject to federal income tax withholding if you have a combat-related injury or illness as determined by your military service at separation that resulted directly from armed conflict; took place while you’re engaged in extra-hazardous service; took place under conditions simulating war, including training exercises such as maneuvers; or was caused by an instrumentality of war. It is also not taxable if you are receiving VA disability compensation or you have received notification from the VA approving such compensation.

(You can read more about tax and veterans benefits here.)

However, some of those benefits were taxed. Specifically, Congress found that “[s]ince 1991, the Secretary of Defense has improperly withheld taxes from severance pay for wounded veterans, thus denying them their due compensation and a significant benefit intended by Congress.” In other words, tax was withheld on those payments when it should not have been.

So at the end of 2016, Congress passed the Combat-Injured Veterans Tax Fairness Act to fix the problem. You can read the Act here (downloads as a pdf).

The Act acknowledges that veterans who included those payments as income are owed a refund. However, since so many veterans didn’t realize that there was a problem, they did not file an amended return before the statute of limitations ran out, so the Act also included a provision to ease those restrictions.
Typically, the statute of limitations for a return is three years from the due date of the return. You can do the math: Since some of the claims may be for tax years beginning in 1991, that would necessarily make it impossible to claim refunds for many of those years.

Now, under the Act, there is an alternative timeframe for affected veterans to claim a tax refund. Most veterans who received a one-time lump-sum disability severance payment when they separated from military service will receive a letter from the Department of Defense. The IRS is working with the Department of Defense to send out those letters, which will explain what kind of refunds might be due, and how to claim those tax refunds. Veterans may claim refunds based on the traditional statute of limitations or one year from the date of the letter from the Department of Defense.
The letters will also include how to file for a refund. Typically, to file for a refund, you file a federal form 1040X, Amended U.S. Individual Income Tax Return. That’s the same method here. However, the amount reported should either be the actual amount of the disability severance payment for which tax was withheld or an amount calculated using a simplified method. Under the simplified method, affected veterans can choose a standard refund amount based on the calendar year in which they received the severance payment. To use this method, simply write “Disability Severance Payment” on line 15 of the federal form 1040X and enter on lines 15 and 22 the corresponding standard refund amount:

$1,750 for tax years 1991 – 2005
$2,400 for tax years 2006 – 2010
$3,200 for tax years 2011 – 2016
No matter which method you use to calculate your refund amount, write either “Veteran Disability Severance” or “St. Clair Claim” on the top of the front page of the federal form 1040X.
Remember: You can’t e-file an amended return. That’s always the case. You must file using paper. If you’re filing an amended return under the Act, send the return, together with a copy of the Department of Defense letter, to:
Internal Revenue Service

333 W. Pershing Street, Stop 6503, P5

Kansas City, MO 64108
So why is the IRS involved with sending the letters as well as the processing of returns? The IRS is forwarding the letters to veterans on behalf of the Defense Finance and Accounting Service (DFAS). The DFAS provides payment services of the Department of Defense, but according to DFAS, it does not have addresses for individuals affected by the new law. The DFAS stresses that the IRS has not disclosed address or any other tax information to DFAS.
The IRS does not have mailing addresses for a small number of veterans. If you are a veteran and are an eligible a refund, but did not receive a letter from Department of Defense, you can still claim your refund by filing a form 1040X. But, since you don’t have the Department of Defense letter, you’ll need to include the following:
A copy of documentation showing the exact amount of and the reason for the disability severance payment, such as a letter from the Defense Finance and Accounting Services (DFAS) explaining the severance payment at the time of the payment or a Form DD-214, and
A copy of either the VA determination letter confirming your disability or a determination that your injury or sickness was either incurred as a direct result of armed conflict, while in extra-hazardous service, or in simulated war exercises, or was caused by an instrumentality of war.
If you did not receive a letter from the Department of Defense and you do not have the required documentation, you’ll need to contact DFAS for more information.
For more information about claiming your refund, check out the IRS.gov website.
https://www.forbes.com/sites/kellyphillipserb/2018/07/30/irs-announces-130000-combat-injured-veterans-may-be-owed-tax-refunds/#57d7909f16d6