Armed Forces Tax Breaks: 1-2-3-4 Don't Want Taxes Anymore

Q: Tax Playa, could you sum up the tax advantages to being in the military, including some of the new provisions from the past year?
Jamie, Groton CT

A: There are many tax advantages given to members of the military.  This balances out some of the disadvantages of being in the military, like (say) getting shot.  More are added all the time in this age of the War on Terror, so people in military households need to stay tax-vigilant...

For more information on this, please consult IRS Publication 3, Armed Forces Tax Guide.

All of the tax advantages available to all taxpayers are also available to military taxpayers.  This article only addresses those special benefits for armed forces households.

The best way to look at all the advantages is to group them into categories:

1. Gross Income

Members of the military receive lots of different kinds of pay.  Some is included, and some is not:

Included: Basic Pay, Special Pay, Bonuses, Miscellaneous Payments, and Incentive Pay
Excluded: Living Allowances, Moving Allowances, Travel Allowances, Combat Zone Pay, Family Allowances, Death Allowances, and In-Kind Military Benefits

--The Pension Protection Act of 2005 allows for a penalty-free withdrawal of IRA money for active-duty military personnel called up to active duty for more than 180 days, provided that activation was between September 11, 2001 and December 31, 2007.  You have two years after the the activation expires to re-deposit the money in a tax-free manner.  Later legislation has made this provision rolling and permanent.

2. Adjustments to Income

--If you are an armed forces reservist and travel more than 100 miles away from home in performance of your duties, you are allowed to take an adjustment for unreimbursed employee business expenses.  Normally, this would only be allowed under the more restrictive rules described elsewhere on this site.

--Excluded combat pay is now allowed to count as earned income for purposes of contributions to IRAs and Roth IRAs.  Furthermore, you are allowed to make a contribution using these loosened rules for any year starting in 2004 (meaning you can make a 2004 or 2005 IRA contribution now if the only reason you couldn't in those years was excluded combat pay).  You have until May 28, 2009 to make these back-contributions.

3. Combat Zone Exclusion

For pretty much all pay earned in a combat zone, there is a blanket exclusion from income tax.

A "combat zone" is an area designated as such by Executive Order of the President.

You can serve in a combat zone even if you are outside the zone, provided you are engaging in direct support of combat and the service qualifies you for special hazard pay.

4. Sale of Home

Normally, there is a requirement that you own and live in your home for 24 of the 60 months prior to sale if you want to exclude up to $500,000 of gain (half that for non-MFJ). There is a special exception for active duty in the military.  If you are on active duty, that counts toward months of your living in the home.

This election is only able to be exercised for ten years after the duty period, and the stationing must be more than 50 miles from the home.  You can only do this for one home at a time.

5. Itemized Deductions

There are a few ins and outs when it comes to unreimbursed employee business expenses. 

--Armed forces reservists can count meetings of their unit as a second place of business.  That means that the cost of traveling there is a deductible business travel expense.

--Uniforms are only deductible if military regulations forbid you from wearing the uniform while off-duty.

--Fees paid to officer's clubs are not deductible as a business expense.

6. Credits

--You can count excluded combat pay as income for purposes of the earned income tax credit.

--If your current year income is less than your prior year income, you can use your prior-year income for purposes of the earned income tax credit.

7. Decedents

--If a member of the U.S. armed forces dies while on duty in a combat zone, the decedent's income tax liability is forgiven that year.

--If a U.S. civilian or military personnel dies as a result of a terrorist attack, the decedent's income tax liability is forgiven that year.

8. Filing Returns and Paying Tax

--If you owe tax, you can defer payment of it for up to 180 days if your service in the military is impeding your ability to pay.  This usually only applies if you are in a combat zone, a hazardous duty area, or a contingency operation.

--If you are stationed overseas, you can file Form 2848 to empower your spouse to sign your return for you.

Comments

[D Bluthenthal]

My spouse is active duty military. I work from home. We are new home owners. (2 yrs).

If I deduct my home office this year, what are the drawbacks for doing so?

I have always deducted a home office when renting a home. But never when owning it. Last year I skipped the whole topic because I didnt understand it. This year I dont want to throw away the deduction if it won't potentially hurt us. We are due to transfer in the next one to two years and may have to sell the home. What do you suggest?
Thanks.

[chet the vet]

I am now CPA but I have never heard that deducting your home office will hurt you in any way.