Under the Arizona military retirement tax exemption, you can subtract 100% of your retired or retainer pay from the uniformed services when figuring your Arizona taxable income, which zeroes out your state tax on that pension.1Arizona Legislature. Arizona Revised Statutes Title 43-1022 – Subtractions From Arizona Gross Income At Arizona’s flat 2.5% income tax rate, that’s $25 saved for every $1,000 of annual retired pay. Federal tax on the same income still applies.
How the Subtraction Works
Arizona doesn’t strip military retired pay out of your income at the top of the return. You start with your federal adjusted gross income, which includes the taxable portion of your pension, and then subtract the full amount of your military retired pay farther down. The result is a full exemption in dollar terms, but the mechanics matter when you fill out the form: the income appears on one line, and the subtraction cancels it on another.
The unlimited subtraction is relatively new. Through 2018, the cap was $2,500. For 2019 and 2020, it rose to $3,500. Starting with tax years after December 31, 2020, the entire amount qualifies with no cap, a change made by S.B. 1331.2Arizona Legislature. Arizona Legislature SB1331 Senate Fact Sheet If you filed a 2021 or later return claiming only the old $3,500, an amended return may recover the difference.
What Retirement Pay Qualifies
The subtraction covers benefits, annuities, and pensions received as retired or retainer pay from the uniformed services of the United States: the Army, Navy, Air Force, Marine Corps, Space Force, Coast Guard, the Public Health Service Commissioned Corps, and the NOAA Commissioned Officer Corps.1Arizona Legislature. Arizona Revised Statutes Title 43-1022 – Subtractions From Arizona Gross Income If your 1099-R comes from DFAS for a military pension, you’re almost certainly covered.
A few categories look military-adjacent but sit outside this subtraction:
- VA disability compensation is already excluded from your federal adjusted gross income, so it never reaches your Arizona return.3Internal Revenue Service. Veterans Tax Information and Services
- Active duty pay is handled through a separate Arizona subtraction for active duty military wages, not this one.
- Reserve or National Guard drill pay is active duty compensation, not retired pay, and doesn’t qualify.
CRDP, CRSC, and VA Waivers
If you have a VA disability rating, DFAS reduces your retired pay by the amount of your VA compensation. That VA portion is tax-free at both levels. Two programs restore some of the offset, and they’re taxed differently:
- Concurrent Retirement and Disability Pay (CRDP), for retirees with a 50% or higher rating, is taxable at the federal level. It flows into your federal adjusted gross income and qualifies for the Arizona subtraction.4Defense Finance and Accounting Service. Combat-Related Special Compensation (CRSC) and Concurrent Retirement Disability Pay (CRDP)
- Combat-Related Special Compensation (CRSC) is non-taxable federally, so it never appears in your federal adjusted gross income and doesn’t need the Arizona subtraction.4Defense Finance and Accounting Service. Combat-Related Special Compensation (CRSC) and Concurrent Retirement Disability Pay (CRDP)
The practical shortcut: use the taxable amount on your DFAS 1099-R. That figure already reflects any VA waiver and excludes non-taxable CRSC. Subtract that number on your Arizona return.
Who Can Claim It
You need to be an Arizona resident or part-year resident receiving retired or retainer pay from the uniformed services. There’s no minimum years-of-service requirement and no discharge-type condition in the statute.1Arizona Legislature. Arizona Revised Statutes Title 43-1022 – Subtractions From Arizona Gross Income
Surviving spouses receiving Survivor Benefit Plan payments also qualify, using the taxable portion of the annuity included in the spouse’s federal adjusted gross income.5U.S. Army. Arizona Military and Veterans Benefits If both spouses in a household draw their own military pensions, each claims the subtraction separately.
Claiming It on Your Return
Full-year residents file Arizona Form 140. Part-year residents use Form 140PY. Either way, the entry goes in the Subtractions from Income section on the line for military retired pay. Line numbers shift when the Department of Revenue redesigns its forms, so check the current year’s instructions before filing.
The amount you enter should match the taxable portion of your military retirement pay shown in Box 2a of your Form 1099-R.6Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498 DFAS uses distribution code 7 in Box 7 for a normal military pension distribution. A different code is worth a second look before you subtract. Keep the 1099-R with your records; it’s the primary documentation if Arizona questions the subtraction.
Stopping Arizona Withholding at DFAS
Since Arizona won’t tax the pension, Arizona withholding on your monthly check just parks your money with the state until you file. You can turn it off through myPay:7Defense Finance and Accounting Service. How to Start, Stop or Change State Income Tax Withholding from Your Military Retired Pay
- Log in to your Military Retiree myPay account.
- Click State Withholding in the left column.
- Update or remove Arizona and submit.
DFAS withholds for only one state at a time. If you have other Arizona-taxable income, dropping withholding entirely could leave you short at filing time. Stopping withholding fits cleanest when your military pension is your only Arizona-taxable income.
Federal Tax Still Applies
The Arizona subtraction doesn’t touch your federal return. Military retired pay stays taxable as ordinary income federally.8Soldier for Life. 2026-01 Get Ready for 2026 Taxes It’s not subject to Social Security or Medicare payroll taxes, because it isn’t earned income.9The Official Army Benefits Website. Federal Taxes on Veterans Disability or Military Retirement Pensions
DFAS withholds federal tax based on the W-4 on file, and you can update it through myPay any time. If withholding won’t cover your federal bill, quarterly estimated payments on Form 1040-ES may be required. The IRS generally requires them when you expect to owe at least $1,000 after withholding and refundable credits, and your withholding covers less than 90% of the current year’s tax or 100% of last year’s (110% if your prior-year adjusted gross income exceeded $150,000).10IRS.gov. 2026 Form 1040-ES – Estimated Tax for Individuals For retirees with no other significant income, adjusting the W-4 through myPay usually keeps you square without touching quarterly vouchers. The estimated-tax rules matter more once you add a civilian salary, investments, or rental income that has no withholding of its own.