War and Terror-Related Injury and Disability Payments: U.S. Tax Treatment for Americans in Israel
Families coping with the trauma of a terror attack or a war injury have already endured more than enough loss and stress. They should not face the burden of unnecessary tax complications on top of their recovery.
TL;DR Practical Takeaways
In many cases, U.S. citizens in Israel do not need to pay U.S. income tax on disability compensation received because of injuries from a terrorist attack, rocket attack, military action, or other qualifying hostile action.
This exclusion is not based on the U.S.-Israel tax treaty. It comes directly from the Internal Revenue Code.
The key rule is found in IRC §104(a)(5). Disability income can be excluded from gross income if it is attributable to injuries incurred as a direct result of a terroristic or military action.
The definition of “terroristic or military action” is found in IRC §692(c)(2). That definition includes certain terrorist activity directed against the United States or any ally of the United States.
For U.S.-Israeli dual citizens, that ally language matters. Israel is an ally of the United States, so Israeli disability payments connected to qualifying terror-related or hostile-action injuries may fall within the U.S. tax exclusion.
The most important practical point: keep documentation. If the payment came from Bituach Leumi, Misrad HaBitachon, or another Israeli agency, you probably will not receive a U.S. Form W-2 or 1099. That does not mean the payment is taxable, but it does mean you need records showing why the payment was made.
Stop here if you just need the practical answer. Keep reading if you want the legal background and a deeper explanation.
The Common Mistake
Many U.S. citizens living in Israel assume that anything received from an Israeli government agency must be reported as taxable income on a U.S. tax return.
That is not always correct.
U.S. citizens are generally taxed on worldwide income. But U.S. tax law also contains specific exclusions. One of those exclusions applies to certain disability payments connected to terrorism or military action.
The right question is not “Did I receive a U.S. tax form?” The right question is “Why was this payment made?”
Example: A U.S.-Israeli dual citizen is injured in a terrorist attack and later receives monthly disability compensation from Bituach Leumi. The taxpayer does not receive a Form 1099. The U.S. tax analysis should focus on whether the payment is disability income tied directly to injuries from a qualifying terroristic or military action.
The Legal Rule
IRC §104 generally deals with compensation for injuries or sickness.
One part of that section, IRC §104(a)(5), excludes from gross income certain disability income attributable to injuries incurred as a direct result of a terroristic or military action.
IRC §692(c)(2) defines “terroristic or military action.” The definition includes certain terrorist activity directed against the United States or any of its allies.
For Americans in Israel, the phrase “or any of its allies” is the bridge between Israeli compensation payments and the U.S. tax exclusion.
Example: A U.S. citizen in Israel receives compensation from Misrad HaBitachon because of injuries sustained in a recognized hostile action. If the payment is truly disability compensation connected directly to that injury, there may be a strong basis to exclude it from U.S. taxable income under IRC §104(a)(5).
This is separate from the U.S.-Israel tax treaty. The exclusion comes from U.S. domestic tax law.
What Types of Payments May Qualify?
The strongest case is for payments that are clearly disability compensation for physical injury or sickness caused by a terrorist attack, rocket attack, military action, or other qualifying hostile action.
The payer may be Israeli rather than American. The payment may come from Bituach Leumi, Misrad HaBitachon, or another Israeli program. The payment may be monthly or lump-sum.
The label on the payment matters less than the legal reason for the payment.
Example: A taxpayer receives an Israeli disability award after being injured in a rocket attack. The award letter states that the payment is based on the injury and the taxpayer’s recognized disability status. That documentation is very different from a general welfare payment, unemployment benefit, or ordinary pension.
Not every payment qualifies. Regular pensions, lost wages, unemployment benefits, general support payments, and unrelated disability benefits may require different treatment.
Documentation Is the Key
Israeli agencies usually do not issue U.S. tax forms. That means the taxpayer needs to build a file.
The file should include the Israeli award letter, the agency decision, medical or disability determination, proof of the event that caused the injury, and annual payment totals. If the documents are in Hebrew, keep an English translation or summary.
A taxpayer claiming the exclusion should be able to show what happened, what injury resulted, who paid the award, and why the payment was made.
Example: A taxpayer receives ₪80,000 during the year from an Israeli agency. The tax file should not simply say “Bituach Leumi payment.” It should identify whether the amount was disability compensation, income replacement, pension, reimbursement, or another type of payment.
For practical U.S. tax filing, the preparer should keep a short workpaper explaining the exclusion and citing the relevant law. That workpaper should connect the facts to IRC §104(a)(5) and IRC §692(c)(2).
Practical Bottom Line
For U.S. citizens in Israel, terror-related disability compensation should not automatically be treated as taxable income.
There is a specific U.S. tax exclusion that may apply when the payment is disability income tied directly to injuries from a qualifying terroristic or military action. The law expressly includes actions directed against U.S. allies, which is especially relevant for Israel.
The best result comes from matching the payment to the law and keeping clear documentation before the IRS ever asks.
Three Action Steps
- Identify the type of payment. Separate disability compensation from pensions, unemployment, lost wages, reimbursements, and general support payments.
- Save the documents. Keep the Israeli agency approval, medical/disability determination, hostile-action recognition, payment summaries, and translations.
- Review before filing. Do not assume the payment is taxable, and do not assume it is excluded. Have the facts reviewed under IRC §104(a)(5), IRC §692(c)(2), and the relevant IRS guidance.
Sources
IRS Publication 525, Taxable and Nontaxable Income:
https://www.irs.gov/publications/p525#en_US_2022_publink1000229319
Internal Revenue Code §104:
https://www.law.cornell.edu/uscode/text/26/104
Internal Revenue Code §692(c)(2):
https://www.law.cornell.edu/uscode/text/26/692#c_2
IRS Publication 3920, Tax Relief for Victims of Terrorist Attacks:
https://www.irs.gov/publications/p3920
MyArmyBenefits, Federal Taxes on Veterans’ Disability or Military Retirement Pensions:
https://myarmybenefits.us.army.mil/Benefit-Library/Federal-Benefits/Federal-Taxes-on-Veterans-Disability-or-Military-Retirement-Pensions
Disclaimer: This article is for educational purposes only. It is not tax advice or legal advice. Taxpayers should consult a qualified tax and/or legal professional regarding their specific facts, documentation, and filing position.