CCH Whole Ball of Tax 2004
Military Service Brings Some Tax Breaks
(RIVERWOODS, ILL., January 2004) – The April 15 tax deadline is one thing that
many men and women in uniform don’t have to worry about this spring, according
to CCH INCORPORATED (CCH), a leading provider of tax law information and software.
Extra time to file is one of a number of tax-related benefits extended to members
of the armed services. And for service members on the most dangerous assignments,
their military pay may be tax-free.
"In general, U.S. tax laws apply equally to civilians and members of the
military," said Mark Luscombe, an attorney, CPA and principal analyst for
CCH. "But Congress has passed laws many times – including this past year
– to make sure that the tax laws don’t add insult to injury for those in danger,
and that people don’t suffer from a tax point of view as a result of their military
Members of the military who are on duty outside the United States or Puerto
Rico, but who are not serving in a combat zone, have until June 15 to file their
taxes. Interest will accrue from the normal due date until the time of payment,
Extra Time to File
If a service member is serving in a designated combat zone, is deployed in
a "contingency operation" or is hospitalized outside the United States
due to an injury received while serving in a combat zone or in a contingency
operation, the due date of the service member’s return is postponed for the
period of the combat service or hospitalization plus 180 days. In addition,
no interest or penalties will be assessed.
The inclusion of "contingency operations" in determining eligibility
for extended filing deadlines was made by the Military Family Tax Relief Act
of 2003 (MFTRA). It expands eligibility to service personnel in operations in
which the Secretary of Defense determines that members of the armed forces may
become involved in military actions, operations, or hostilities against an enemy
of the United States or against an opposing military force. It also covers callups
during a war or during a national emergency declared by the President or Congress.
The combat zone/contingency operation filing extension (which also includes
service in qualified hazardous duty areas) also
applies to other tax-related time limits. This includes such things as paying
income and estate taxes, instituting Tax Court proceedings, filing refund claims,
making contributions to qualified retirement plans and making distributions
"Taxpayers should write ‘Combat Zone’ across the top of returns and documents
to bring these items to the immediate attention of the IRS or the Tax Court,"
Normally, military pay is taxable. This includes compensation with all sorts
of names: active duty pay, reserve training pay, enlistment or re-enlistment
bonuses, incentive pay, readjustment pay and travel and per diem allowances.
Pay for service in a combat zone is an exception. All compensation for active
service for any month in which a service member serves in a combat zone is exempt
from income tax, up to the highest rate of enlisted pay, which was $5,882.70
per month in 2003. So if someone begins service in a combat zone on the last
day in January and leaves the combat zone on the first day of December, the
entire year’s pay is exempt.
It has long been felt that there is something wrong about taxing the earnings
of those who pay the ultimate price in service to their country, so the law
provides a total income tax exemption for the earnings of those who die as a
result of wounds, disease or injuries incurred in a combat zone.
The exclusion applies to service member’s entire income, not just military
pay, and it applies to the entire calendar year in which the death takes place.
For example, income taxes have been abated on a deceased service person’s share
in a partnership’s income from the date of death to the end of the partnership’s
The exclusion also applies to prior years, back to the first year of service
in a combat zone. This means that family members can file amended returns to
have prior years’ taxes refunded, although a statute of limitations – usually
three years from the normal due date of a return – applies.
Military death benefits, like civilian life insurance proceeds, are now totally
tax-free. Since 1991, due to a glitch in drafting a benefits increase, only
half of the $6,000 death benefit had been free of tax. The Military Family Tax
Relief Act (MFTRA) increases the benefit to $12,000 and excludes the entire
amount from tax for deaths occurring after September 10, 2001.
The MFTRA also ensures that certain special benefits extended to living members
of the military and their families won’t be considered taxable income. Dependent
care is one of these. The Department of Defense operates one of the largest
child care programs in the U.S. and provides dependent care assistance to members
of the Armed Forces. The new law makes it clear that beginning with the 2003
tax year, these benefits are excluded from income. Another special program involves
military homeowners whose properties decline in value when a base closes or
reduces operations. In cases where the government reimburses them for the loss
they suffer on the private sale of their homes, the payments they receive are
excluded from their income.
MFTRA also modified the exclusion on sales of personal residences to take account
of the mobile nature of many military careers. Single filers can exclude up
to $250,000 of gain from the sale of their principal residence while married
taxpayers filing jointly can exclude up to $500,000 of gain. But the exclusion
is subject to an ownership and use test.
The taxpayer has to own and use the property as his or her principal residence
for at least two years during the five-year period that ends on the date of
MFTRA created a special exception to the two-out-of-five-year rule for uniformed
and foreign service personnel called to "qualified official extended duty"
– any period of active duty for more than 90 days or for an indefinite time
at a duty station that is at least 50 miles from the taxpayer’s principal residence.
In that case, they can elect to suspend the five-year test period. The maximum
length of the suspension is 10 years, and it can only be made for one property.
If the election is made, the five-year period ending on the date of the sale
of a principal residence does not include any period up to 10 years during which
the serviceman or woman, or his or her spouse, is on qualified official extended
duty. The election may be revoked at any time.
Help for Reservists and Students
Also as a result of MFTRA, members of the Reserve and the National Guard can
now take an above-the-line deduction for service-connected travel expenses in
connection with trips that take them more than 100 miles away from home and
that involve an overnight stay. The deduction is limited to the general federal
per diem rate, which varies by locality. Up until 2003, this kind of deduction
was available only to those who itemized their deductions and was subject to
the limitation on miscellaneous itemized deductions.
MFTRA also provides relief to students who have received appointments at the
United States Military, Navy, Air Force, Coast Guard and Merchant Marine academies
and who have savings in tax-advantaged 529 accounts. Up until now, they have
been caught in a tax Catch-22 because amounts in 529 accounts can only be withdrawn
without penalty to pay for educational expenses – but students appointed to
service academies technically are being paid for their services and have no
educational expenses. Beginning with the 2003 tax year, they can withdraw a
pro-rata amount from the accounts each year they are in school without having
to pay the 10-percent penalty. The amounts withdrawn are included in their gross
"The theme behind much of MFTRA was to fix situations in which the tax
laws unwittingly had created penalties for people serving in the military,"
Luscombe noted. "In some cases, if people drafting legislation years ago
had given a little more attention to the unique situations of military members
and their families, the problems that the MFTRA tries to solve would never have
State Rules Vary
The rules for federal taxation of military pay and benefits can be complex,
but at least they apply to all uniformly. Not so with the states.
Most states with an income tax use taxable income from the federal return as
a starting point in calculating the state tax. In those cases, items excluded
from federal taxation normally also escape taxation at the state level.
One thing to watch for, though, is whether a state adopts the federal rules
as of a certain date. For example, for 2003 taxes, a state may adopt federal
law as it existed on January 1, 2003. This means that unless the legislature
acts, the provisions of the MFTRA, enacted in November of 2003, can’t be used
on 2003 returns.
"Some states exempt combat pay, some exempt pay for guard and reserve
training, some exempt all military pay, some exempt a certain amount and some
tax all of it," Luscombe said. "Fortunately, the web pages for many
states’ departments of revenue address how military pay is taxed, but anyone
with any doubts should consult a qualified tax professional with a knowledge
of the specific state’s rules."
About CCH INCORPORATED
CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and
has served more than four generations of business professionals and their clients.
The company produces more than 700 electronic and print products for the tax,
accounting, legal, securities and small business markets. CCH is a Wolters Kluwer
company. The CCH Federal and State Tax group, CCH Tax Compliance and Aspen Publishers
Tax and Accounting group comprise the new Wolters Kluwer Tax and Accounting
unit. The unit’s web site can be accessed at tax.cchgroup.com.
-- ### --