Tax Benefits for Military Personnel
There are many tax benefits for military personnel, with combat pay exclusion being primary. Other forms of income, such as allowances, are also tax-free. Additionally, there is tax forgiveness on income earned by a taxpayer who died because of combat. Military personnel also have special deductions and more favorable rules for some of those deductions, such as travel expenses. Military personnel may also have extended times for filing and paying taxes. Special rules apply to reservists.
Members of the Armed Forces or active duty reservists can exclude compensation received for serving in a combat zone or when hospitalized because of injury or disease incurred while serving in a combat zone. Commissioned officers can exclude compensation equal to the highest enlisted pay rate, plus special pay for hostile fire and imminent danger. ($225! Evidently, the Armed Services decided that $225 is enough compensation for risking your life! At least, it's tax-free.) The taxpayer can elect to treat nontaxable combat pay as earned income when figuring the earned income tax credit.
All other compensation is taxable, including taxable fringe benefits. Combat pay exclusion can also be applied to military pay received while outside of a combat zone if the taxpayer provided services designated by the Defense Department to directly support military operations in a combat zone and the taxpayer is entitled to receive special military pay for exposure to hostile fire or imminent danger. Combat pay exclusion applies to bonuses paid by states or municipalities to military personnel who have served in a combat zone.
Combat zones are designated by the President of the United States through an Executive Order to those geographic areas in which the US Armed Forces are engaging or have engaged in combat; likewise, a geographic area ceases to be a combat zone by Executive Order. IRS Publication 3 lists all current combat zones.
Differential wages, which are wages equal to the difference between military pay and the employee's former pay, paid to employees who enlist or who are called up to active duty for a period exceeding 30 days, cannot be excluded as combat pay. FICA (Federal Insurance Contributions Act) taxes — Social Security and Medicare taxes — do not have to be withheld on differential wages if the active military service exceeds 30 days; otherwise, differential wages are subject to withholding for both FICA and income taxes.
Besides excluded combat pay, other tax-free income for military personnel and their families include:
- allowances for:
- housing (BAH) and subsistence (BAS)
- housing and cost-of-living for residing in a foreign country
- moving-in housing allowance to offset expenses for occupying leased space outside of the US, such as rental agent fees, home security improvements, and supplemental heating equipment
- temporary lodging expenses, for temporary lodging for up to 10 days within the United States or up to 60 days abroad
- relocation expenses incurred in relocating a household, including temporary living charges and hotels, lease forfeitures, and other such expenses
- educational expenses
- travel during leave between consecutive oversee tours, reassignment in a dependent restricted status, and transportation during ship overhaul or inactivation, and annual roundtrips for dependent students
- emergencies, evacuation to safety, and separation
- burial services and travel expenses of dependents to the burial site
- death gratuity payment of $100,000 to immediate family members or someone else designated by the decedent
- ROTC education and subsistence
- education, training, or subsistence paid because of any law administered by the Veterans Administration (VA)
- adjustments and compensation for losses resulting from foreign exchange
- survivor and retirement protection plan premium payments
- medical or hospital treatment provided by government hospitals in the US
- dividends from G.I. insurance or interest on dividends left on deposit with the Department for Veteran Affairs
- life insurance proceeds from the Servicemembers Group Life Insurance
- compensation paid by the US government to former prisoners of war.
- defense counseling payments
Disability retirement pay, but not Social Security disability payments, for a combat related injury are tax-free to members or former members of the Armed Forces of any country, the Coast Guard, the Foreign Service, the National Oceanic and Atmospheric Administration, or the Public Health Service. If a disabled member received payments while waiting for a determination by the VA in regards to disability status, then the statute of limitations is extended for claiming a refund for payments that should not have been taxed because of the determination to the later of:
- 3 years after the due date of the return or
- 1 year after the date of disability determination.
Payments to disabled veterans under the Compensated Work Therapy (CWT) for vocational rehabilitation services are also tax-free.
Distributions from retirement plans and IRAs to reservists younger than 59½ are not subject to the 10% early withdrawal penalty. Military death gratuities or payments from the Servicemembers' Group Life Insurance (SGLI) can be rolled over to a Roth IRA or Coverdell Educational Savings Account within 1 year of receipt by beneficiaries. These rollovers are not subject to limits on contribution amounts or income.
Home Sale Exclusion: Suspension of 5-Year Ownership and Use Test
Military personnel can exclude gain on their home just like anyone else, up to $250,000 for individuals or $500,000 for a couple filing jointly. However, the 5-year ownership test can be suspended during qualified official extended duty. The taxpayer is still required to live in the residence for at least 2 years, but the 5-year test for owning the home immediately before the sale and living in it for at least 2 of those years can be extended to include the time on qualified official extended duty. So if you lived in your own home for 4 years before entering active duty, then went on extended duty for 6 years, meanwhile renting out your residence, then returned home, but sold your old residence for a new residence, then you would still qualify for the home gain exclusion, even though you did not live in your home for 2 of the 5 years previous to the sale.
Tax Forgiveness Due To Death Attributed to Combat
Tax liability is forgiven for those military personnel killed in a combat zone or who died from wounds or disease incurred in a combat zone. The tax forgiveness applies to the year of death and any prior years that were served in the combat zone. The estate of the deceased is entitled to any refunds because of the tax forgiveness. Tax forgiveness also applies to any civilian or military US government employee killed in a terroristic or other military action, regardless of whether the injury or death occurred in a combat zone. The taxpayer must have been a US employee on the date of both injury and death.
To substantiate the requirements for tax forgiveness, the following documents must be filed:
- Form 1310, Statement of Person Claiming Refund Due a Deceased Taxpayer
- certification from the Department of Defense, on DD Form 1300, Report Of Casualty.
Additionally, to claim tax forgiveness for a deceased civilian employee of an agency other than the Department of Defense requires certification through a letter signed by the Director General of the Foreign Service, Department of State, or a delegate thereof.
Previous to the 2017 Tax Cuts and Jobs Act (TCJA), the following military expenses can be deducted as a miscellaneous itemized deduction subject to the 2% AGI floor, but the 2017 TCJA eliminated these deductions:
- military battle dress uniforms and utility uniforms that are not permitted to be worn off duty
- special wearable military articles, including insignia of rank, corps devices, epaulets, aiguillettes, and swords
- costs of altering rank insignia, color devices, gold braids, and other indicators of rank, because of promotions or demotions
- costs that exceed the clothing allowance for obtaining and cleaning uniforms that are only permitted to be worn on duty
- reservists' uniforms that are worn only to perform duties as a reservist
- transportation, food, and lodging expenses incurred on official travel status
- out-of-pocket moving expenses for a permanent change of station which are not subject to the 50-mile and 39-week test, calculated on Form 3903, Moving Expenses
- reimbursements for board and lodging costs that exceed those paid by the government for temporary duty away from the home base
- travel expenses incurred while away from the home port or base, not including a permanent duty station or permanent duty aboard a ship, are deductible.
- dues paid to professional societies, but not officers' and noncommissioned officers' clubs
- subscriptions to professional journals
Extensions for Filing and Paying Tax
Tax deadlines — for filing returns, paying taxes, filing refund claims, making IRA contributions, and filing a Tax Court petition — are extended by at least 180 days for military personnel serving in a combat zone. Extensions may also apply to a spouse. The 180-day period begins after the later of:
- serving in a combat zone or in a contingency operation that serves a combat zone
- the last day that qualifies as a combat zone or as a contingency operation, or
- the last day of hospitalization for injuries suffered in a combat zone or contingency operation.
Time served as a prisoner of war or while missing in action counts as serving time in a combat zone.
A taxpayer entering the Armed Forces who is unable to pay his taxes because of the military service can receive an extension of 180 days after leaving the military to pay the tax. As long as the inability to pay was because of the military service and the tax is paid within the extended period, no interest or penalties will be assessed.
Previous to the 2017 Tax Cuts and Jobs Act (TCJA), travel costs for reservist meetings were deductible according to the usual rules for deducting transportation costs, as miscellaneous itemized deductions subject to the 2% AGI floor, and either the standard mileage rate or the actual expense method were available, but the 2017 TCJA eliminated this deduction. However, costs for transportation and lodging, and 50% of the cost of meals incurred by traveling overnight to a meeting or training camp located more than 100 miles from home can be deducted as an above-the-line deduction not subject AGI limits and does not have to be itemized.
Reservists called to active military duty exceeding 179 days can receive distributions, called qualified reservist retirement distributions, from a traditional IRA or from a 401(k) or 403(b) plan without incurring a 10% tax penalty, even if they are younger than 59½. The amount distributed can also be re-contributed to a traditional IRA, but not to a 401(k) or 403(b) plan, as a nondeductible contribution within 2 years after active duty ends.
Reservists can also withdraw their entire balance from a health flexible spending arrangement and use the proceeds for any purpose, but only if the employer allows qualified reservist distributions and the amount is withdrawn before the regular reimbursement deadlines for healthcare costs.
Reservists unable to pay their taxes because they were called to active duty may defer the payment of those taxes without interest or penalty.