State of Legal Residence for Retirees

Residency for Military Retirement

I’ve read quite a few questions lately from recent retirees who are confused about their state of legal residency, and where they need to file their state income taxes.  State of legal residence for retirees is an important issue, and ideally you are thinking about it long before you actually retire, and definitely while you are planning your post-military life.

Active duty military members are permitted to retain their state of legal residence even when Permanent Change of Station (PCS) orders require them to live elsewhere.  This protection comes from the Servicemembers Civil Relief Act.  Military spouses, depending on their situation, may be able to retain their state of legal residence as they move with their active duty service member.  This protection comes from the Military Spouses Residency Relief Act.

Once the service member retires, both partners lose these protections, and must follow the same residency rules as civilians.  This generally means that they have to pay state income tax to the state in which they actually reside.  That can be a big shock, especially if they’ve been legal residents of a state with no state income tax.  With state income tax rates running as high as 13.3% (for the highest tax bracket in California), not planning for state income taxes can be a big shock.  Even with a relatively average rate of 7-8%, we’re talking about some significant money.  Depending on the state, retired military members may be paying on taxes on their military retirement pay, any investment or other income, and/or pay from their second career.

Another surprise is how much of total military compensation is non-taxable.  Only pays, such as base pay and special pays, are taxable.  Allowances, such as housing allowance, are non-taxable.  What this means is that even if you’re making the same total amount of compensation from your retirement job as you made from your active duty job, you may well be paying significantly more taxes on it.

So, what can a prospective (or recent) retiree do?  Most importantly, be aware of the tax consequences of the choices you make with regard to where you work and live.  Be sure that you are factoring in all the variables, including which sources of income are taxed in your desired state, and the cost of those state taxes.

Once you make a decision about where you’re going to put down roots, be sure that each payer, including new jobs and the Defense Finance and Accounting Service (DFAS) has the correct state and federal tax withholding information so that you aren’t stuck with a huge bill at the end of the tax year.  I’ve heard many recent retirees report that they forgot to change their state withholding with DFAS and it was a tax-time hassle.

About the Author

Kate Horrell
Kate Horrell is a military financial coach, mom of four teens, and Navy spouse. She has a background in taxes and mortgage banking, and a trove of experience helping other military families with their money. Follow her on twitter @realKateHorrell.
  • CW5 Graves

    I would like to give an update from the state of North Carolina (NC) for military personnel. NC recently passed a law that any individuals who have served in the military service and retired, DO NOT pay state income tax. This change is referred to as the “Bailey Act”. We moved from Florida (which has no tax income tax) to North Carolina (due to the Bailey Act)and have not paid state income tax since our retirements (my husband is also retired military). I would suggest that individuals who do plan on moving or have retired from military service, contact a lawyer/accountant who knows the roots of what the state may offer to retired military.

    • Kate

      As I understand the Bailey decision, it only applies to retirement income earned from a government plan in which the plan participant had met certain vesting thresholds by 12 August 1989. It does not apply to all military retirement income, nor does it apply to any other type of income that is earned after military service (such as investment income or income from a second career.) The Bailey decision affects few enough people that North Carolina is generally not included in any lists of states that do not tax military retirement income.

      It is always important to thoroughly check all the nuances of the state tax laws before making a decision.

      Thanks for reminding those who had 5 years of creditable service on 12 August 1989 that there is a special situation for them with regard to North Carolina state income taxes on their military pensions.

  • Howard HELTON

    that means one must pay the new “state of legal residency” taxes on the capital gains from selling a house in the former state. For example, as a Florida Resident (with no income tax), I became a “legal resident of the Commonwealth of Virginia” when I retired. Two years later I sold a rental house in Florida that had been depreciated over the years to “zero”. I had to pay $8,900 capital gains tax to Virginia. Guess I helped pay the Virginia State Utility Bill that month! Had not planned for that.

    • Kate

      This is one of the many important tax issues that people don’t think about. I’m curious – would you have done anything differently if you had known about this??

      Thanks for the comment.

  • Summer Rose

    Right now, Kentucky does not tax Social Security or other States Public Employees retirements because they do not tax their own.
    Military retirees are not taxed IF they retired before a certain date/year, which I believe is like 1990-92.
    A person would need to see for themselves what the date is.
    After that date, a portion of the military retirement pay is taxed.
    As I military retired in 1987 I came under the no tax rule, which was nice having moved from WA state where there is no State Income tax, as neither my military or civilian LEO retirements are taxed. I was medically retired from that in 2002.
    I had fully expected to be taxed, so you can believe it was a truly wonderful thing to find out I was not to be.
    Learned about it from the Tax Person I used in 2004 when I first moved to KY.
    As in any tax matters, States can and will change their laws/rules when they believe they need to gain more funds for their coffers.
    So as we all know, nothing is ever “cut in stone” when it comes to taxes.
    Taxes RARELY go down, but always seem to go up.
    I fully agree with the premise of the article, check and look before you move anywhere. Along with taxes; this also should be checked out: WHAT IS the actual cost of living where you are thinking about moving to.