As we watch the evening news, we see our fighting men and women of the Armed Forces in combat areas far from home. The reports can fill us with a myriad of emotions, like patriotism, compassion, empathy for the families, and a desire to give back in some way. Many of us in this industry can show our gratitude by offering discounted or free returns to thank individuals personally for their dedication and commitment to this country. So let’s change gears and slow down to ask the question, “How up-to-date is your ‘intel’ on the tax breaks for those in the military and especially for those in a combat zone?” Until recently, I depended on my software to help by checking the boxes labeled active duty and combat zone. I felt there might be more, so I pushed forward and found some things you might find interesting.
First of all, what is considered a combat zone? We all know about the Arabian Peninsula area and Afghanistan, but did you realize that the Kosovo area, Federal Republic of Yugoslavia (Serbia and Montenegro), Albania, the Adriatic Sea, and the Ionian Sea north of the 39th Parallel are also designated as a combat zone or qualify for hazardous duty pay. How about areas outside the hot zones that support our troops in combat? You bet. The current list includes Pakistan, Tajikistan, Jordan, Incirlik Air Base (Turkey), Kyrgyzstan, Uzbekistan, Philippines, Yemen, Djibouti, Israel, and Somalia (last updated 17-Feb-2016).
Who Qualifies and What are the Benefits
Now that we have identified the combat zone, let’s talk about who qualifies for these special benefits on a tax return. Under IRC §112, only officers and enlisted personnel of the Armed Services are eligible for combat zone benefits. This list includes the U.S. Army, Marines, Air Force, Navy, Activated Reservists, and the Coast Guard. It unfortunately does not include the American Red Cross, US Merchant Marines, or civilian personnel who support the military in the war effort. They may, however, qualify for the foreign earned income exclusion by filing Form 2555.
First and foremost is the exclusion of wages and state bonus payments from taxable income. This exclusion of wages will be automatic on the W-2 Form. There is a limitation on this exclusion for officers. Officers cannot exempt an amount greater than the highest enlisted member is paid. For 2016, that amount is $7,683.30 per month. In addition, they receive $225 per month for combat pay which is also exempt. So why do they receive a W-2 if there is non-taxable income? It’s due to the fact that Social Security and Medicare must be assessed against their wages.
These soldiers receive this combat exclusion for any part of the month they arrive in or depart from a combat zone. For example, a soldier could arrive in a combat zone on January 28 and depart the region on December 1, and qualify for a full 12-month exclusion on wages. Now what about troops that are injured and evacuated to a hospital outside the combat zone? As long as they are hospitalized with a combat related medical condition, they continue to receive the combat pay exclusion until they are discharged from the hospital (up to 5 years).
In a worst case scenario, what if they die from a combat related injury or disease? Under IRC § 692, all federal income tax is abated for the year of death and earlier years they were stationed in the combat zone. In addition, any outstanding IRS tax debts are also forgiven. Here’s where we can help: identify the specific combat zone followed by KIA (Killed in Action) in bold red letters at the top of the Forms 1040 or 1040X. For example, you might write, “AFGHANISTAN – KIA” or “KOSOVO AREA – KIA.”
We need to prepare returns and amendments on all tax years that are impacted by this tax forgiveness. In most cases, these amended returns will qualify for refunds. The IRS Kansas City Campus handles KIA returns, so they need to be mailed to Internal Revenue Service, 333 W Pershing, Stop 6503, P5, Kansas City, MO 64108 (include a DOD Death Certificate and Form 1310).
Benefits for the Family
How does a soldier’s family benefit if their loved-one is serving in a combat zone? Under IRC §7508 and Rev. Rul. 76-425 a combat service-member is given an automatic extension for filing and for paying tax due. This automatic extension continues to run for 180 days after re-assignment out of the combat zone. So if you are worried about getting the extensions filed on your active duty combat soldiers, you have now been given a reprieve: It’s automatic! This extension also encompasses the soldier’s spouse – even if Married Filing Separately (MFS) – and dependents. Not all situations (especially if getting a refund) will consider this extension financially prudent or practical. So use good judgment. As mentioned in a related scenario; you will need to indicate in bold red letters at the top of the 1040 “Combat Zone Extension” or some similar wording to alert the IRS. This automatic extension also covers Gift & Estate Tax returns and Schedule H (1040) Household Employment Taxes. It does not cover Regular Employment Tax Returns (940, 941, 943, 944), Business Returns (1120, 1120S, 1065), or Excise Tax Returns (Form 720). Refer to Notice 2003-21 for additional guidance.
Under Notice 2012-41, the Military Spouses Residency Relief Act, civilian spouses of active military service members may now select their state of domicile along with the service member or they may choose their own state of domicile. Also see Notices 2010-30 and 2011-16. This benefit and other family benefits extends to same-sex marriages. Registered domestic partners do not qualify for these benefits, but may qualify for state veteran benefits in Nevada, Washington, and California.
What about combat zone soldiers Missing in Action (MIA)? Under §6013(f), the spouse may file a joint return for the initial MIA year and all subsequent years the combat zone designation stays in effect. Since the military assumes an MIA is still alive, the combat pay should continue to the spouse or heirs. Should the combat zone designation be terminated, the spouse can continue to file jointly for two additional years. If the remains of a soldier who was MIA are found and the status is changed to KIA, there may be additional benefits that activate (see previous section).
Survivors receiving a military death benefit have some amazing choices that non-military recipients do not have. They can roll-over their military death benefit (up to $100,000) into a ROTH IRA or a Coverdell ESA. This allows the death gratuity, as well as, the Service-members’ Group Life Insurance benefit to both be rolled-over (within the $100,000 limit). As with all ROTHs and ESAs special rules apply in withdrawing the funds. So a word to the wise: be cautious of “maxing-out” the roll-over provision, especially if you expect that monetary needs may arise shortly after the transfer. For more information see the HEART ACT §109.
The Earned Income Tax Credit and the Child Tax Credit both allow exempt combat pay to be used in their respective worksheets to qualify. Since this often requires manual input, be sure you pick-up on these credits for the soldier’s family. The Child and Dependent Care Credit does not allow the use of combat pay on its worksheet. Therefore, a parent’s income excluded under Code §112 (combat zone) cannot be used on Form 2441 to qualify for the dependent care credit.
Next, let’s look at the §121 Sale of Residence exclusion and any exceptions for the military. As you may have already guessed, the 5-year holding period is extended to 10-years for soldiers stationed away from home while serving on active duty (tour must exceed 90 days). On another note, soldiers stationed in the United States on temporary duty assignments can actually count their temporary duty-time towards satisfying the 2-year residency requirement.
How about the non-taxable housing allowance that members of the Armed Forces receive. Does this prevent them from deducting their mortgage interest and property tax? Absolutely not! Just like our taxpayers in the clergy receiving a parsonage allowance, the military gets to “double-dip” on the mortgage interest and property tax deduction.
What about soldiers receiving exempt combat zone pay making an IRA contribution? This is also allowed and you can read more about it in the 2006 HERO Act, Notice 2006-129.
What about the spouse signing the tax return for a soldier in the combat zone? In the absence of a power of attorney, the spouse can designate “combat zone authority” to sign both as the taxpayer and spouse on a joint return.
Moving expenses for the family of a service member being re-assigned are also deductible within the scope of applicable moving expenses, and civilian employment and distance requirements do not apply to military moves. If the service member has been assigned outside the country and military housing has been withdrawn, the family’s move to be near other family is authorized even if the spouse does not seek employment and the move is only a few miles away. Unfortunately, you cannot double-dip if the military has allocated these costs tax free or reimbursed the moving costs.
Other Related Benefits
There are other benefits for our soldiers that extend beyond the tax return. One in particular goes back to the Servicemembers Civil Relief Act of 2003 (SCRA), which stipulates that Active Duty Servicemembers can request a 6% interest cap on credit cards, car loans, mortgages, and other debts that were in place prior to starting on active duty. The service member must make a written request stating they believe that active duty pay materially affects their ability to repay the financial obligation at a higher interest rate and provide proof of military activation after the account was opened.
Reservists that are activated to serve in combat usually get overlooked on SCRA, a mistake I made in the past that you should avoid. Interest in excess of 6% must be forgiven (not deferred) by the creditor. Furthermore, the 6% interest rate cap stays in effect until the service member pays off the debt, is discharged from the service, or dies. Any new charges to credit cards or refinancing of existing balances are not eligible for the 6% interest rate cap.
SCRA also grants soldiers special privileges with the courts. It allows judges to extend, stay, or defer court and administrative proceedings on a soldier or their family. It allows a service member that is being transferred the right to terminate real estate leases within 90 days of deployment. The same rights apply for vehicle lease termination if the service member will be deployed for more than180 days or is being transferred outside the United States. In addition, foreclosure protection under certain circumstances can be granted by the court and all mortgage payments suspended until the soldier returns.
The service member may request the court place a stay on their civil proceedings, like divorce or bankruptcy until returning from active duty. Even ‘statutes of limitation’ can be extended by the court for the amount of time the service member was deployed outside the United States. It also protects the service member’s family from being evicted on leases that do not exceed $3,329.84 per month. Click here for more information about SCRA.
Additional benefits come from the Department of Veterans Affairs (VA), which include 100% home loan financing up to $417,000 (lower 48 states) for active duty soldiers or veterans once they leave the service and medical benefits for low-income veterans, providing them with free medical care and medications.
Many of the states have special benefits for active duty soldiers and veterans. Some of these benefits include a free Veterans Driver’s License & Car Tags, Educational Benefits at public universities and colleges, Veteran State Tax Exemptions, Financial Aid, and Housing Assistance. Again a link has been provided at the end of our discussion to help you learn more.
Helpful Web Sites and Links
If you would like to read more on tax breaks and benefits for the military in general, share your thoughts with the ALSEA Board Members for future sessions.
Combat Zones and Combat Support Areas
Keyword: Combat Zones
Servicemembers Civil Relief Act of 2003
Tax Forgiveness for Soldiers Killed in Action
Keyword: Combat Zone Forgiveness
Department of Veterans Affairs
Keyword: VA Benefits
State Veterans Benefits
Keyword: State Veterans Benefits
ABOUT THE AUTHOR:
Ben Tallman is a Tax Practitioner from Atlanta, Georgia. He has taught as an instructor of local, state, and national organizations for the past decade. Ben has served on the NAEA National Board as an Educational Foundation Trustee, as a member of the IRS Regional Liaison Committee, and as Educational Director for GAEA.