2012 CCH Whole Ball of Tax
Special Tax Support for U.S. Military Personnel
(RIVERWOODS, ILL., January 2012) – For members of the U.S. Armed Forces serving our country around the globe, tax time can be particularly strenuous, especially when duty may leave little time to even think about filing a tax return. For those stationed in places such as combat zones, or overseas peacekeeping missions and even serving in earthquake-ravaged countries providing humanitarian aid – special support is granted at tax time. CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com), details some of the special tax provisions provided to qualifying, members of the military.
Combat Pay Status, Exemptions
Normally, military pay is taxable. But, for military members serving in a combat zone as an enlisted person or as a warrant officer (including commissioned warrant officers) for any part of a month, all military pay received for military service that month is excluded from gross income and not subject to taxes. For commissioned officers, the monthly exclusion is capped at the highest enlisted pay, plus any hostile fire or imminent danger pay received.
In fact, all compensation for active service in a combat zone for any month, including a state or local bonus paid while serving in a combat zone, is exempt from income tax, up to the highest rate of enlisted pay – currently $7,489.80 per month – plus Hostile Fire Pay / Imminent Danger Pay of $225 per month. So if service in a combat zone begins on the last day in January and ends on the first day of December, the entire year’s pay is tax exempt. However, other military compensation such as active duty pay, reserve training pay, enlistment or re-enlistment bonuses, incentive pay, readjustment pay as well as travel and per diem allowances is taxable – only pay for service in a combat zone is an exception.
Military personnel may count combat pay as earned income for the purpose of making contributions to traditional and Roth IRAs, which can only be made out of earned income. Veterans also are eligible for subsidized mortgages financed by state bonds that are usually available only to first-time homebuyers. Veterans can use these programs even if they have previously bought a home, but they can use them one time only.
Other military tax assistance and benefits include:
- Extension of deadlines : The time for taking care of certain tax matters may be postponed. The deadline for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS is automatically extended for qualifying members of the military;
- Free tax preparation help : Most military installations offer free tax filing and preparation assistance during the filing season;
- Joint returns : In general, joint income tax returns must be signed by both spouses. However, when one spouse may not be available due to military duty, a power of attorney may be used to file a joint return; and
- Transitioning back to civilian life : Military personnel leaving active duty and starting new careers may be able to deduct some costs incurred looking for a new job including travel, resume preparation fees and outplacement agency fees. Moving expenses may be deductible if the move is closely related to the start of work at a new job location, and certain tests are met. Tax credits available to employers for hiring veterans were also expanded in 2011.
“Generally, the tax code applies equally to civilians and members of the military,” said CCH Principal Tax Analyst Mark Luscombe, JD, LLM and CPA. “However, Congress has also passed many laws to make sure military personnel and families are not burdened with tax regulations made more difficult by military service.”
Extra Time for Tax Filing
If a service member is serving in a designated combat zone, is deployed in a “contingency operation” or is hospitalized outside the United States because of 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 combat zone / contingency operation filing extension (which also includes service in qualifiedhazardous 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. Also, 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.
Death Provides Exclusion
Families who unfortunately lose loved ones killed in battle are not faced with the additional financial burden of paying taxes on what the deceased had earned while serving his or her country. 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 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. In addition, for deaths from injuries on or after June 17, 2008, military death gratuities and Servicemembers Group Life Insurance benefits can be rolled over into a Roth IRA or Coverdell education savings account regardless of normal contribution limits to those tax-advantaged savings vehicles.
The law now provides that certain survivor benefits such as accelerated vesting or ancillary life insurance benefits that would be granted if an employee returned to work and then died must be provided to the beneficiaries of a participant who dies during qualified military service before returning to work.
There is no requirement that plans increase benefits based on time spent on active duty for participants who fail to return to work based on death or disability, but the law now authorizes plans to do that, treating the situation as though the employee had returned to work the day before the death or disability took place.
Penalty-free Retirement Savings Withdrawals
In 2006, Congress provided a new benefit for military personnel called to active duty after September 11, 2001. As a result of the Pension Protection Act, those called to serve are allowed to make penalty-free withdrawals from their IRAs, 401(k)s and similar tax-advantaged plans. In addition, they will have two years after the end of their period of service to repay the distribution into the plan, and thus avoid income tax, as well as the 10-percent penalty, on the withdrawal.
“A call to active duty can be a serious financial hardship for a National Guard member with a full-time civilian job or a small business,” Luscombe noted. “This provision softens the economic blow by allowing access to otherwise restricted retirement savings. But they will lose tax-advantaged earnings while the money is out of the plan and could face income taxes and penalties if they fail to repay the distribution.”
Reservists called to active duty may also withdraw their funds in a Health Flexible Spending Account (FSA). The special provision prevents forfeiture of money set aside in an FSA that was originally intended to cover medical expenses before year’s end – expenses that would now be covered by the military.
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 for a loss incurred on the private sale of their homes, the payments they receive are excluded from their income.
There are special rules for the sales of personal residences to take account of the mobile nature of many military careers. In general, 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.
Normally, a 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. However, there’s 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 at least 50 miles from the taxpayer’s principal residence. In that case, they can elect to suspend the five-year test period.
Help for Students, Reservists
Members of the Reserve and the National Guard can take an above-the-line deduction for service-related travel expenses in connection with trips that take them more than 100 miles away from home and involve an overnight stay. The deduction is limited to the general federal per diem rate, which varies by locality.
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 used to be caught in a tax catch-22. Amounts in 529 accounts can only be withdrawn without penalty to pay for educational expenses – but students appointed to service academies don’t pay tuition or other education expenses.
A tax rule enacted in 2003 enabled qualified students to 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 tax legislation pertaining to the military in recent years has been to fix situations in which older tax laws unwittingly had created penalties for people serving their country,” Luscombe noted.
Variable State Tax Laws
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 knowledge of the specific state’s rules.”
About CCH, a Wolters Kluwer business
CCH, a Wolters Kluwer business (CCHGroup.com) is a leading global provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. CCH is based in Riverwoods, Ill. Follow us now on Twitter @CCHMediaHelp. Wolters Kluwer (www.wolterskluwer.com) is a market-leading global information services company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands.