2006 CCH Whole Ball of Tax
Members of the Military Get Special Tax Treatment
(RIVERWOODS, ILL.,
January 2006) – Thousands of men and women in the military will receive
special tax treatment this year, including extra time to file, according
to CCH, a Wolters Kluwer business and a leading provider of tax and accounting
law information, software and services (tax.cchgroup.com). 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, JD, CPA and CCH principal federal
tax law analyst. “But Congress has passed laws many times to make sure that
people don’t suffer from a tax point of view as a result of their military
service.”
Extra Time to File
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, however.
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 expanded 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 call-ups during a war or 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 taking distributions
from IRAs.
“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,” Luscombe noted.
Special Rules for Combat Pay
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 $6,304.20 per month in 2005. 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.
In 2004, as part of the Working Families Tax Relief Act of
2004, Congress addressed another issue relating to combat pay. Since it is
not taxed, combat pay is not considered “earned income,” and this can lessen
eligibility for the earned income tax credit and the child credit. Under
the new law, members of the military can elect to have combat pay earned
in 2005 counted as earned income for figuring both credits, and this provision
has been extended to cover 2006 combat pay, as well.
Death Provides Exclusion
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 the service member’s entire income,
not just military pay, and it applies to the entire calendar year in which
the death occurs. 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 fiscal year.
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, such as 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. MFTRA
increased the benefit to $12,000 and excluded the entire amount from tax
for deaths occurring after September 10, 2001.
Tax-free Benefits
MFTRA also ensured 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 United States and
provides dependent care assistance to members of the Armed Forces. The law
makes it clear that 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.
The Act 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 sale.
The Act 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.
The Act also provided 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 could 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
income, however.
“The theme behind much of the Military Family Tax Relief
Act 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 MFTRA
tries to solve would never have arisen.”
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.
Many states with an income tax use taxable or adjusted gross
income from the federal return as a starting point in calculating the state
tax. In those cases, items excluded for federal purposes normally also escape
taxation at the state level, but not all states follow this practice.
“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 doubts should consult a qualified tax professional with a
knowledge of the specific state’s rules.”
About CCH, a Wolters Kluwer business
CCH, a Wolters Kluwer business (tax.cchgroup.com)
is a leading provider of tax, audit and accounting information, software
and services. It has served tax, accounting and business professionals and
their clients since 1913. Among its market-leading products are The ProSystem fx® Office, CCH® Tax Research NetWork™, Accounting
Research Manager™ and the U.S. Master Tax Guide®. CCH is based in
Riverwoods, Ill.
Wolters Kluwer is a leading multinational publisher and information
services company. Wolters Kluwer has annual revenues (2004) of €3.3 billion,
employs approximately 18,400 people worldwide and maintains operations across
Europe, North America and Asia Pacific. Wolters Kluwer is headquartered in
Amsterdam, the Netherlands (www.wolterskluwer.com).
Its depositary receipts of shares are quoted on the Euronext Amsterdam (WKL)
and are included in the AEX and Euronext 100 indices.
-- ### --
nb-06-12
|