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, and anything above that is taxed at the state’s flat 3.5% individual income tax rate.1Department of Revenue. 2026 Kentucky Withholding Tax Formula Retirees who began drawing their pension before January 1, 1998, pay no Kentucky tax on it at all, regardless of amount.2Department of Revenue. Military Exemptions
How the $31,110 Exclusion Works
Kentucky lets you subtract up to $31,110 of retirement income from the figure the state 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.3Kentucky Legislative Research Commission. Kentucky Revised Statutes 141.019 If your total taxable pension income is $31,110 or less, none of it reaches your Kentucky tax bill.
The limit is per taxpayer, not per pension. A retiree with $20,000 in military retired pay and $15,000 from a private 401(k) has $35,000 in combined pension income, and only $31,110 of that total can be excluded under the standard rule. The remaining $3,890 is taxable at 3.5%.
You claim the subtraction on Schedule M, line 9, and that amount drops out of your Kentucky adjusted gross income.4Department of Revenue. Schedule M (2025) Kentucky Federal Adjusted Gross Income Modifications Skip the paperwork and Kentucky taxes the full pension amount that transferred from your federal return.
When Your Entire Pension Is Tax-Free
If you started receiving military retired pay before January 1, 1998, Kentucky exempts the entire pension with no dollar cap.5Department of Revenue. Kentucky Individual Income Tax Instructions for Forms 740 and 740-EZ Enter the full amount as a subtraction on Schedule M. Schedule P is not needed because the $31,110 cap does not apply to this group.
What matters is the date payments actually began, not your separation date. Someone who left active duty in 1997 but did not start drawing retired pay until 1999 falls under the post-1997 rules and uses the $31,110 exclusion.
Excluding More Than $31,110 With Schedule P
Retirees whose pensions started after December 31, 1997, and whose government pension income exceeds $31,110 may qualify for a larger exclusion through Kentucky Schedule P.6Department of Revenue. Schedule P (2025) Kentucky Pension Income Exclusion Military retired pay counts as a federal pension for this purpose.
Schedule P calculates an “exempt percentage” based on the share of your career performed before January 1, 1998. You multiply your taxable pension by that percentage, and the result is added to the standard $31,110 exclusion. If all of your service was after 1997, your exempt percentage is zero and the standard $31,110 is your ceiling.
The percentage is calculated once, in the year you first file Schedule P, and carried forward on later returns. The final figure flows to Schedule M, line 9, which reduces your Kentucky adjusted gross income on Form 740.4Department of Revenue. Schedule M (2025) Kentucky Federal Adjusted Gross Income Modifications
What to File
The exclusion requires three documents working together:
- Your 1099-R from the Defense Finance and Accounting Service, which reports your taxable retired pay.
- Form 740, Kentucky’s individual income tax return, which starts with your federal adjusted gross income.
- Schedule M, where you enter up to $31,110 of pension income on line 9. If you also have active duty pay, it goes separately on line 13.
Schedule P is added to the stack only if your government pension income exceeds $31,110 and you have pre-1998 service credit. Part-year residents file Form 740-NP instead of Form 740, and the pension subtraction appears on page 4 of that form rather than on Schedule M. The 2025 Kentucky return is due April 15, 2026.7Finance and Administration Cabinet. Kentucky Tax Filing Season Begins Jan. 26
Other Military Income Is Treated Differently
Several payments that reach military retirees are not retired pay and follow different rules. Lumping them together can lead to overpaying or underreporting.
Active Duty Pay
All military pay earned on active duty, including National Guard and Reserve members on active duty orders, is fully exempt from Kentucky tax with no dollar limit. It is claimed on Schedule M, line 13, separately from the pension exclusion. Weekend and annual training drill pay also qualifies under this exemption.8Department of Revenue. Military Tax Issues
VA Disability Compensation
Disability payments from the Department of Veterans Affairs are excluded from federal gross income, so they never enter your federal adjusted gross income and are automatically invisible to Kentucky.9Internal Revenue Service. Veterans Tax Information and Services No subtraction or special form is required.
Combat-Related Special Compensation
CRSC is exempt from federal income tax under Section 104 of the Internal Revenue Code.10Defense Finance and Accounting Service. Combat-Related Special Compensation Guidance It stays out of your federal adjusted gross income and out of your Kentucky return. CRSC arrives in a separate check from your retired pay.
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.11Defense Finance and Accounting Service. CRDP-CRSC FAQs CRDP raises your federal adjusted gross income and is subject to the same Kentucky exclusion rules as regular retired pay.
Survivor Benefit Plan Annuities
SBP payments to a surviving spouse are generally taxable at the federal level and reported on a 1099-R. The surviving spouse can claim Kentucky’s $31,110 pension exclusion on their own Schedule M the same way the retiree would have.2Department of Revenue. Military Exemptions
Federal Tax Still Applies
Kentucky’s exclusion only touches state tax. Military retired pay remains fully taxable at the federal level, falling into the regular graduated brackets that run from 10% to 37% for 2026.12Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Nothing about Kentucky’s treatment changes your federal bill.
A Pending Change to Watch
The $31,110 figure has held since 2018. House Bill 183, introduced in the 2026 Kentucky legislative session, would raise the exclusion to $41,110 beginning in 2027. The bill has not been enacted.13Kentucky Legislative Research Commission. 26RS HB 183 Until it passes, plan on $31,110.