Does Kentucky Tax Military Retirement Pay? The $31,110 Exclusion

Yes, Kentucky does tax military retirement pay, but most retirees pay tax on only a small portion of it, if any. Every taxpayer can exclude up to $31,110 of pension income from Kentucky taxable income each year, and retirees who started drawing their pension before January 1, 1998, can exclude the whole amount with no cap.¹ Anything above the exclusion is taxed at Kentucky’s flat 3.5% individual income tax rate.²

The $31,110 Pension Exclusion

Kentucky lets you subtract up to $31,110 of retirement income from the figure the state actually taxes. The exclusion covers military retired pay along with federal civilian pensions, state and local government pensions, private employer plans, IRAs, 401(k) distributions, and annuities.³ If your total pension income for the year is $31,110 or less, none of it is subject to Kentucky income tax.

The cap is per taxpayer, not per source. If you draw $20,000 in military retired pay and another $15,000 from a 401(k), your combined pension income is $35,000. Only $31,110 comes off; the remaining $3,890 is taxable at 3.5% unless you qualify for a larger exclusion through Schedule P.

The exclusion was $41,110 through tax year 2017 and dropped to $31,110 starting in 2018. It has stayed at $31,110 since, including for tax year 2026.¹

Full Exemption For Pre-1998 Retirees

If you began receiving military retired pay before January 1, 1998, your entire pension is exempt from Kentucky income tax with no dollar cap.⁴ You report the full amount as a subtraction on Schedule M, line 9, and no Schedule P is required.

The date that matters is when your retired pay actually started, not when you left active duty. A service member who separated in 1997 but did not start drawing retired pay until 1999 falls under the post-1997 rules and is limited to the standard exclusion.

Schedule P: When You Can Exclude More Than $31,110

Retirees who started drawing their pension after December 31, 1997, but have some pre-1998 service, may be able to exclude more than $31,110 by filing Kentucky Schedule P.⁵ Military retired pay counts as a federal pension for this purpose.

Schedule P calculates an “exempt percentage” based on the share of your career served before January 1, 1998. You multiply your taxable pension by that percentage, and the resulting amount is added to the standard $31,110 exclusion. If all of your service was after 1997, the exempt percentage is zero and you are held to the $31,110 cap.

You only calculate the exempt percentage once, in the first year you file Schedule P. The same percentage carries forward on future returns. The final Schedule P figure flows to Schedule M, line 9, which reduces your Kentucky adjusted gross income on Form 740.⁶

How To Claim The Exclusion On Your Return

The exclusion is not automatic. If you skip the forms, Kentucky taxes the full pension amount that came over from your federal return. The paperwork sequence:

DFAS sends you Form 1099-R in late December or January showing your taxable retired pay.
Your federal adjusted gross income transfers to Kentucky Form 740 as the starting point.
On Schedule M, enter up to $31,110 of pension income on line 9 (or the larger amount from Schedule P).⁶
Complete Schedule P only if your government pension income exceeds $31,110 and you have pre-1998 service credit.⁵

The deadline for filing your 2025 Kentucky return is April 15, 2026.⁷ Part-year residents file Form 740-NP instead of Form 740.

Other Military Income Kentucky Treats Differently

The rules above cover retired pay. Other payments a veteran or retiree may receive follow different rules.

Active duty pay is fully exempt from Kentucky income tax with no dollar limit, including drill pay for National Guard and Reserve members. It goes on Schedule M, line 13, separately from the pension line.⁸

VA disability compensation is excluded from federal gross income, so it never enters your Kentucky calculation in the first place.⁹ No Kentucky form or subtraction is needed.

Combat-Related Special Compensation (CRSC) is exempt from federal income tax under Section 104 of the Internal Revenue Code and stays out of your Kentucky return the same way.¹⁰

Concurrent Retirement and Disability Pay (CRDP) works differently. When you receive CRDP, your VA waiver decreases and your taxable retired pay increases by the same amount, so CRDP is subject to the same Kentucky exclusion rules as regular retired pay.¹¹

Survivor Benefit Plan (SBP) annuities paid to a surviving spouse are taxable federally and qualify for the same $31,110 Kentucky pension exclusion the retiree’s own pension would have.¹ The surviving spouse claims it on their own Schedule M.

Federal Tax Still Applies

Kentucky’s exclusion has no effect on what you owe the IRS. Military retired pay is fully taxable at the federal level, and for tax year 2026 it falls into the same graduated brackets as any other income, from 10% to 37%.¹² You can adjust federal withholding through myPay or by sending a W-4 to DFAS, but setting withholding to zero does not eliminate the tax; it only delays the bill until you file.

1
Department of Revenue. Military Exemptions
2
Department of Revenue. 2026 Kentucky Withholding Tax Formula
3
Kentucky Legislative Research Commission. Kentucky Revised Statutes 141.019
4
Department of Revenue. Kentucky Individual Income Tax Instructions for Forms 740 and 740-EZ
5
Department of Revenue. Schedule P (2025) Kentucky Pension Income Exclusion
6
Department of Revenue. Schedule M (2025) Kentucky Federal Adjusted Gross Income Modifications
7
Finance and Administration Cabinet. Kentucky Tax Filing Season Begins Jan. 26
8
Department of Revenue. Military Tax Issues
9
Internal Revenue Service. Veterans Tax Information and Services
10
Defense Finance and Accounting Service. Combat-Related Special Compensation Guidance
11
Defense Finance and Accounting Service. CRDP-CRSC FAQs
12
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026