If you are receiving a service connected disability retirement from Merced County Employees' Retirement Association (MCERA), all or a portion of your benefits may be nontaxable. The Internal Revenue Code provides special tax treatment if you retire due to a service-connected disability.
Determining if Amount is Tax Free
If your service connected disability pension is no more than half of your final average salary as determined by MCERA, the entire amount is generally tax free because it is in the nature of workers compensation. If your service connected disability pension is more than half of your final average salary, then generally the portion that equals half of your final average salary is tax free and the remainder is taxable. However, if you retire on a disability under a statutory presumption that it is service connected (e.g., for heart trouble or cancer), generally the Internal Revenue Service and Franchise Tax Board will not treat your pension as tax free.
In addition, if all or part of your pension is tax free because it is service connected, then generally any related COLA is tax free. The COLA will be prorated so that, for example, if three-fourths of your pension is tax free, then three-fourths of the COLA will be tax free.
If you receive any taxable amount from MCERA, the entire benefit paid to you will be reported in Box 1 of the 1099-R as Gross Distribution. The taxable amount reported in Box 2a will be reduced by any tax free service connected disability and by a portion of your after-tax contributions calculated using the rules for regular retirement payments as set out below.