It's legal and respectful to dispose of the American Flag buy burning in a solemn ceremony. Many VFW's have ceremonies during the year to dispose of old, tatered flags.
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My flag is old and ready to be retired. What should I do? Section 8k of the Flag Code (see below) states, "The flag, when it is in such condition that it is no longer a fitting emblem for display, should be destroyed in a dignified way, preferably by burning." We recommend that you contact your local VFW Chapter and ask them for help properly disposing of your flag. And be sure to consider providing a small donation to them for their assistance. Or you can contact your local Elks Lodge (who created the idea of Flag Day, established officially by President Truman, himself a member of the Elks), the American Legion, or the Knights of Columbus. Some Boy Scout and Girl Scout troups also can provide this service.
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http://www.ushistory.org/betsy/flagetiq.html