Federal Employee Tax Guide: TSP, FERS, Commuting and Retirement

Thousands of people in the Fredericksburg region work for the federal government. Some commute up I-95 to the Pentagon, Washington or Northern Virginia, some head to Quantico or Dahlgren, and many telework part of the week. Federal pay has its own tax rules: the TSP, pre-tax health premiums, a FERS pension that is only partly taxable, and the occasional shutdown or buyout. This federal employee tax guide covers all of it for 2026, along with the Virginia rules that apply when you live here and work in DC or Maryland.

TSP in 2026: limits, and traditional vs. Roth

The Thrift Savings Plan works like a 401(k), and it has the same IRS limits. Your traditional and Roth contributions count toward one combined limit. Agency automatic (1%) and matching contributions don't count toward it.

New for 2026: because of SECURE 2.0, if your 2025 FICA wages were over $150,000, all of your 2026 catch-up contributions must be Roth. The TSP handles this automatically. Once your traditional contributions reach $24,500, anything more lands in your Roth balance.

Which one should you choose?

• Traditional TSP lowers your taxable wages now. Withdrawals are taxed later, by both the IRS and Virginia. It usually makes sense if you're in the 22% bracket or higher now and expect a lower bracket in retirement.
• Roth TSP gives you no deduction now, but qualified withdrawals are tax-free, and Virginia doesn't tax them either. It's often the better choice for newer employees in the 10% or 12% bracket and for anyone who expects a large FERS pension to fill the lower brackets later.
• A mix is common, and sensible. It gives you some control over taxable income in retirement, which also affects how much of your Social Security is taxed and your Medicare premiums.

Pre-tax benefits: FEHB, FSAFEDS and your paycheck

Two federal benefits cut all of your payroll taxes, not just income tax:

• FEHB premiums (premium conversion). Executive-branch employees pay their share of health premiums before federal income, Social Security and Medicare taxes are figured, and in most cases before state tax too. Retirees can't use premium conversion: once FEHB comes out of your annuity, it's paid with after-tax dollars.
• FSAFEDS. For 2026 you can set aside up to $3,400 in a health care or limited-expense FSA and up to $7,500 per household in a dependent care FSA ($3,750 if married filing separately). That dependent care limit was $5,000 before the 2025 tax law. You can carry up to $680 of unspent health care FSA money into 2027 if you re-enroll.

Your FERS retirement contribution is the item people forget. It comes out of every paycheck, but it isn't pre-tax: you pay income tax on it now. Most employees hired before 2013 contribute 0.8% of pay, those hired in 2013 contribute 3.1%, and those hired in 2014 or later contribute 4.4%. Those already-taxed dollars come back to you tax-free in retirement, which is why your annuity isn't fully taxable at first.

Living in Virginia, working in DC or Maryland

Virginia has reciprocity agreements with DC and Maryland, among others. The rules:

• DC: Virginia residents who don't establish residency in DC are exempt from DC income tax. If you work for a contractor or private employer in DC, give them Form D-4A (Certificate of Nonresidence in DC) so it doesn't withhold DC tax.
• Maryland: a Virginia resident working in Maryland is exempt from Maryland withholding on wages if they don't live in Maryland for more than six months of the year. Claim the exemption on Form MW507. If Maryland tax was withheld anyway, file nonresident Form 505 to get it back.
• Virginia: you report all of your wages on Virginia Form 760 and pay Virginia tax on them. Make sure your employer withholds Virginia tax, using Form VA-4.

Federal employees usually update their state of residence through their agency's self-service payroll system rather than a paper form. After a move from Maryland or DC to Spotsylvania or Stafford, check your next Leave and Earnings Statement. A stale state code can mean a year of withholding to the wrong jurisdiction, then a refund claim in one state and a balance due in the other.

Shutdowns, back pay, buyouts and resignation programs

Shutdown back pay

Back pay after a lapse in appropriations is ordinary wages. It's taxed in the year you actually receive it and shows up on that year's W-2, with normal withholding. If you collected unemployment benefits during a shutdown and had to repay them, the year matters:

• Repaid in the same year: subtract the repayment from the unemployment you report, and write "Repaid" and the amount next to the line.
• Repaid in a later year: if the repayment is more than $3,000, you can take an itemized deduction or a credit, whichever saves more (the "claim of right" rule). Smaller repayments generally get no deduction.

VSIP, VERA and leave payouts

• VSIP (buyout): up to $25,000, and it's taxable wages. Your agency withholds federal and state income tax, Social Security and Medicare, so the check is noticeably smaller than the gross amount. If you take federal employment again within five years, you generally have to repay the entire VSIP before you start.
• VERA (early retirement): the annuity is taxed like any other FERS annuity, as explained below.
• Annual leave payout: taxable wages in the year paid. A payout in early January lands in the next tax year, which can help if you retire late in the year.

The 2025 Deferred Resignation Program

Employees who took OPM's 2025 Deferred Resignation Program stayed on paid administrative leave, generally through September 30, 2025 (December 31 for some retirement-eligible employees), with full pay and benefits. That pay was ordinary W-2 wages, and the lump-sum leave payout at separation was too. There was no special tax treatment. If you also started a second job during that period, check your 2025 withholding. Two employers each withholding as if they were your only job can leave you owing.

How your FERS annuity is taxed

Each monthly annuity payment has two parts: a tax-free return of your own contributions (your "cost") and the taxable rest. Your cost is the total of your FERS contributions shown on your OPM annuity statement. It includes any deposit you paid to buy back military or other service. For annuities starting after November 18, 1996, IRS Publication 721 requires the Simplified Method:

1. Find your cost. Total contributions from OPM, say $21,700.
2. Look up the number of payments. Single-life annuity (Table 1): age 55 or under, 360; 56–60, 310; 61–65, 260; 66–70, 210; 71 or older, 160. With a survivor annuity, use Table 2 and your combined ages: 110 or under, 410; 111–120, 360; 121–130, 310; 131–140, 260; 141 or over, 210.
3. Divide. $21,700 ÷ 310 = $70 a month tax-free for someone retiring at 60 without a survivor annuity.
4. Repeat each year until the whole $21,700 is recovered. After that, every dollar is taxable.

OPM sends Form CSA 1099-R each January showing the gross annuity and, usually, the taxable amount. Check it against your own worksheet, especially in the first year, when you may have received only a few months of payments.

The FERS supplement

If you retire on an immediate, unreduced annuity before 62 (for example at your minimum retirement age with 30 years of service), OPM adds the annuity supplement, which approximates the Social Security you earned with FERS service until you reach 62. The supplement is paid by OPM as part of your annuity, so for tax purposes it's treated like the rest of the annuity, not like a Social Security benefit. That means Virginia's Social Security subtraction doesn't apply to it. Two other points:

• It's subject to an earnings test: if your wages or self-employment earnings exceed Social Security's annual exempt amount ($23,400 for 2025), it's reduced $1 for every $2 over. Pensions, TSP withdrawals and investment income don't count.
• MRA+10 retirees, disability retirees and deferred retirees don't receive it at all.

Deferred and postponed retirement

If you leave federal service before you're eligible for an immediate annuity, you may qualify for a deferred annuity at your MRA or 62. An MRA+10 retiree can postpone the annuity to reduce the age penalty. Either way, nothing is taxed until payments start, and the Simplified Method uses your age when they do.

Virginia taxes on federal retirement income

Virginia starts from your federal adjusted gross income, so the taxable part of your FERS annuity, the FERS supplement and traditional TSP withdrawals are all Virginia income. Roth TSP qualified withdrawals and Social Security are not. Three rules matter most:

• No federal pension subtraction. Virginia's military retirement subtraction (up to $40,000) doesn't cover CSRS or FERS annuities or TSP, even if the annuity includes bought-back military time.
• Age deduction. At 65 or older you can deduct up to $12,000 per person. Unless you were born on or before January 1, 1939, it shrinks $1 for every $1 of "adjusted federal AGI" (federal AGI minus taxable Social Security) above $50,000 for single filers or $75,000 for married couples. A single retiree with a $60,000 annuity keeps only $2,000 of the deduction, while a married couple at the same income, both 65 or older, keeps the full $12,000 each.
• Withholding. Retirement income usually has less tax withheld than a paycheck. Ask OPM or the TSP to withhold more, or plan for Virginia estimated payments on Form 760ES.

Our guide to retirement taxes in Virginia walks through the age deduction phase-out and Social Security in detail. If you also have military retired pay, see the military tax guide.

Telework, contractors and common mistakes

Telework and home offices. If you're paid on a W-2, as a federal employee or as a contractor's employee, you can't deduct a home office, internet, a desk or commuting costs. Miscellaneous itemized deductions for unreimbursed employee expenses were suspended in 2018, and the 2025 tax law made that permanent. Only self-employed people, such as a 1099 consultant or someone with a side business, can deduct a home office, and only for their own business.

Transit benefits. Agency transit subsidies for VRE, commuter buses or Metro are tax-free up to $340 a month in 2026. Anything above that is taxable wages.

Mistakes we see most often:

• Maryland or DC tax withheld after a move to Virginia, never reclaimed.
• Going over the TSP limit, or missing agency matching, after switching agencies mid-year.
• Reporting the whole FERS annuity as taxable in year one instead of using the Simplified Method.
• No extra withholding or estimates in the first year of retirement, then an April bill from both the IRS and Virginia.
• Assuming Virginia exempts federal pensions the way it exempts Social Security.
• Repaying a VSIP from a new federal job without adjusting for the tax that was originally withheld.

Retiring, taking a buyout or changing jobs is the time to model your taxes, not April. Our tax planning team can project your first retirement year, test traditional vs. Roth choices and set up OPM and Virginia withholding, and our tax preparation service handles the Simplified Method and multi-state W-2s every season. Our office is in Fredericksburg, but we work with federal employees and contractors throughout Virginia and in other states remotely, through a secure client portal. You can also check your Virginia numbers with our Virginia income tax calculator.

Written by the Timeless Tax & Accounting teamTimeless Tax & Accounting was founded in 2020 by Nagham Alobaidi and serves clients across Virginia and in other states, in English and Arabic. Reviewed for accuracy against IRS and Virginia Tax guidance as of October 2, 2026.

This page is general information, not tax, legal or financial advice for your specific situation. Tax rules change often — talk with a professional before acting.