VA Compensated Work Therapy (CWT) Program: Tax Rules by Component

Payments from the VA’s Compensated Work Therapy program are tax-free when they come from the Transitional Work component, but wages from the Supported Employment component are taxed like any other job. That split is the whole story of VA Compensated Work Therapy tax treatment, and getting it wrong is what leads to surprise tax bills or missed refunds. The rest is detail: how to file, what documents to expect, and how CWT income interacts with Social Security, VA pension, and the Earned Income Tax Credit.

Which CWT Component You’re In Decides the Tax Question

CWT has three models, and only one of them pays you through the VA. In Transitional Work (TW), you’re legally a patient in a rehabilitation program, not an employee. Your pay comes from the VA’s Special Therapeutic and Rehabilitation Activities Fund at the prevailing wage for the job, with a floor of the federal minimum wage of $7.25 per hour (or the higher state or local minimum where applicable).¹ The patient classification comes from 38 U.S.C. § 1718.²

In Supported Employment (SE) and Community Based Employment Services (CBES), a community business hires you, puts you on its payroll, and pays you directly. CWT staff and job coaches support you clinically, but the employer of record is the private business. That distinction drives everything about how the money is taxed.³

Why Transitional Work Pay Is Tax-Free

For more than 40 years, the IRS treated CWT payments as taxable compensation under Revenue Ruling 65-18 and required the VA to report them on Form 1099. In 2007, the U.S. Tax Court ruled in Wallace v. Commissioner that CWT payments are veterans’ benefits protected by 38 U.S.C. § 5301 and therefore exempt from federal income tax. The IRS accepted that result, issued Revenue Ruling 2007-69 revoking the 1965 rule, and confirmed the payments as qualified military benefits under Internal Revenue Code § 134.⁴ The VA stopped issuing 1099 forms for these payments after the ruling.⁵

Because TW pay is not wages, the VA withholds no federal income tax, no Social Security tax, and no Medicare tax. You keep every dollar.⁶

Supported Employment Wages Are Taxed Like Any Job

When you move into SE or CBES, a community employer runs your paycheck through normal payroll. That employer withholds income tax and FICA, issues a W-2 in January, and reports your wages to the IRS.³ The fact that you were placed through CWT and receive on-site coaching does not change any of that. For tax purposes you are a regular employee of the business that hired you, and you file accordingly.

This is where confusion costs veterans money. “CWT” gets treated in casual conversation as if it always means tax-free. It doesn’t. If your paycheck comes with tax withholding and a W-2, that income is taxable regardless of the CWT connection.

How to File and What to Do About a Mistaken 1099

If your only CWT participation was Transitional Work, you will not receive a W-2 or a 1099 for that pay. Don’t list it on the wages line of Form 1040, and don’t list it anywhere else. It doesn’t belong on the return. If TW payments and non-taxable VA disability compensation are your only income, you may not be required to file a federal return at all.

If you had Supported Employment or CBES wages, report the W-2 the same way you would for any job.

Occasionally a veteran receives a 1099 for TW payments in error, usually where participation straddled the 2007 policy change or ran into administrative confusion. If that happens, contact your CWT vocational specialist. They can provide a correction or a letter explaining that the payments are tax-exempt veterans’ benefits under Revenue Ruling 2007-69. Keep the letter with your tax records in case the IRS sends a notice asking about the unreported income.³

The Tradeoff: No Social Security Credits from Transitional Work

Because no FICA is withheld from TW pay, none of it counts toward your Social Security record. You don’t earn quarters of coverage, and the earnings don’t factor into your future retirement or disability benefit calculation.⁶ That’s the price of the tax exclusion. If Social Security credits matter to your long-term plan, this is worth raising with your treatment team when discussing how long you’ll stay in TW versus moving toward SE.

Earned Income Tax Credit

TW payments do not qualify as earned income for the Earned Income Tax Credit. The IRS lists veterans’ benefits among the income types excluded from the EITC earned-income calculation.⁷ If TW pay is your only income, the EITC isn’t available on that basis.

SE and CBES wages are different. They’re regular W-2 employment income, they count as earned income, and they can make you eligible for the EITC if you meet the other rules. For veterans moving from TW into competitive work, the credit is worth checking at filing time.

Effect on SSI and SSDI

For Supplemental Security Income, TW payments are excluded from countable income. SSA treats them as a medical service rather than earnings, so they don’t reduce your SSI check. SE wages, by contrast, are earned income for SSI and will be counted in the monthly calculation, which can reduce or eliminate the payment.³ If you’re on SSI and your team recommends moving into SE, talk with both your vocational specialist and your SSA caseworker before you start.

For Social Security Disability Insurance, TW payments generally do not trigger Trial Work Period months because they aren’t classified as wages or earned income. SE wages do count. In 2026, any month you earn more than $1,210 counts as a trial work month, and nine such months within a rolling 60-month window trigger an SSA reevaluation.⁸

Effect on VA Pension and Disability Compensation

TW earnings are excluded from countable income when the VA calculates pension eligibility and amount. The VA’s financial assessment specifically carves out CWT and Incentive Therapy earnings.⁹ The Board of Veterans’ Appeals has confirmed that distributions from the VA Special Therapeutic and Rehabilitation Activities Fund are excluded from countable income for improved pension purposes.¹⁰ Participating in TW will not jeopardize your VA pension or reduce your VA disability compensation.

State Income Tax

Most states follow the federal treatment of veterans’ benefits, so TW payments are generally not subject to state income tax either. State codes vary, though, and a few states have their own rules on what counts as taxable income. If you live in a state with an income tax, confirm with your state’s revenue department or a tax preparer familiar with veterans’ benefits that TW payments are excluded on your state return. States without an income tax, such as Texas, Florida, and Nevada, remove the question entirely.

1
U.S. Department of Veterans Affairs. Information for Veterans – Compensated Work Therapy
2
Office of the Law Revision Counsel. 38 USC 1718 – Therapeutic and Rehabilitative Activities
3
Social Security Administration. POMS SI 00830.311 – Veterans Affairs (VA) Incentive Therapy (IT) and Compensated Work Therapy (CWT) Programs
4
Internal Revenue Service. Internal Revenue Bulletin 2007-49 – Revenue Ruling 2007-69
5
U.S. Department of Veterans Affairs. Pay in Vets’ Work Program Ruled Tax-Free
6
Social Security Administration. POMS RS 01402.485 – Department of Veterans Affairs (VA) Incentive Therapy (IT) and Compensated Work Therapy (CWT) Programs
7
Internal Revenue Service. Taxable and Nontaxable Income
8
Social Security Administration. Trial Work Period
9
Department of Veterans Affairs. Reference Guide: Income and Expenses for Financial Assessment (IB 10-454)
10
Board of Veterans’ Appeals. Citation Nr 20002127