Tax Benefits for Service Members

Gross Income

Service Members receive many different types of pay and allowances. Some of these pay and allowances are included in the calculation of gross income for federal income tax purposes while others are excluded from this calculation. The amount of savings from federal income taxes could be substantial. Consider the types of pay below that are included and excluded in the calculation of gross income for federal income tax purposes:

- Pay Included in the Calculation of Gross Income 

1. Basic pay (active duty, attendance at a designated service school, back wages, CONUS COLA, drills, reserve training, training duty).
2. Special pay (aviation career incentives, foreign duty – outside the 48 contiguous states and the District of Columbia, foreign language proficiency, hardship duty, medical and dental officers, optometry, pharmacy, veterinarian).
3. Bonuses (career status, enlistment, officer, overseas extension, re-enlistment).
4. Other payments (accrued leave, high deployment per diem).
5. Incentive pay (flight pay).

This list in not all inclusive. Unless payment is for services provided while in a CZ or QHDA, such pay is included in the Service Member’s calculation of gross income for federal income tax purposes.

- Pay Excluded in the Calculation of Gross Income

1. Living allowances (Basic Allowance for Housing, Basic Allowance for Subsistence, Overseas Housing Allowance, Housing and cost-of-living allowances abroad whether paid by the U.S. government or by a foreign government).
2. Moving allowances (dislocation, military base realignment and closure benefit, moving household and personal items, storage, temporary lodging and temporary lodging expenses).
3. Travel allowances (per diem, leave between consecutive overseas tours).
4. Combat Pay (compensation for service while in a CZ or QHDA – note: limited exclusion for certain officers as explained below).
5. Death allowances (burial services, death gratuity payments to eligible survivors, travel of dependents to burial site).
6. Other payments (disability, including payments received for injuries incurred as a direct result of a terrorist or military action, group term life insurance, professional education, ROTC educational and subsistence allowances, uniform allowances, uniforms furnished to enlisted personnel).
7. In-kind military benefits (dependent care assistance program, legal assistance, medical/dental care, commissary/exchange discounts, space available travel on government aircraft).

These exclusions apply whether the item is furnished or is a reimbursement or an allowance.

Adjustments to Gross Income

If you are a member of a reserve component of the Armed Forces and travel more than 100 miles away from home in connection with your performance of services as a member of the reserves, you can deduct your non-reimbursable travel expenses as an adjustment to income, rather than as a miscellaneous itemized deduction. The deduction is limited to the amount the federal government pays its employees for travel expenses.

-Combat Pay

What is a Combat Zone?

A Combat Zone (CZ) is an area that the President of the United States has designated by Executive Order as an area that the Armed Forces have engaged in combat. The Executive Order will designate the geographical area and the time period in which serve must have occurred to be eligible to receive combat zone benefits. There are currently three areas that have a CZ designation:

- Arabian Peninsula/Persian Gulf area. By Executive Order No. 12744, the following locations (and airspace above) were designated as a combat zone beginning January 17, 1991.

1. Persian Gulf
2. Red Sea
3. Gulf of Oman
4. Part of the Arabian Sea that is north of the 10 degrees north latitude and west of 68 degrees east longitude.
5. Gulf of Arden
6. The total land areas of Iraq, Kuwait, Saudi Arabia, Oman, Bahrain, Qatar, and the United Arab Emirates.

 - Kosovo area. By Executive Order No. 13119 and Public Law 106-21, the following locations (including the airspace above) were designated as a combat zone beginning March 24, 1999.

1. Federal Republic of Yugoslavia (Serbia and Montenegro)
2. Albania
3. Adriatic Sea
4. Ionian Sea north of the 39th parallel.

 - Afghanistan. By Executive Order No. 13239, Afghanistan (and the airspace above) was designated as a combat zone beginning September 19, 2001.

All of the above CZ designations are still open, and will remain open until terminated by another Executive Order.

What is a Qualified Hazardous Duty Area (QHDA)?

A Qualified Hazardous Duty Area (QHDA) is an area designated by Congress in the form of a law. As with the CZ, Service Members may invoke the tax relief only if they have served in the QHDA during the eligible time period designated in the law. Congress can enact legislation terminating a QHDA at any time.

Public Law 104-117 designates parts of the former Yugoslavia as a QHDA beginning November 21, 1995. The countries entitled to QHDA status include: Bosnia, Herzegovina, Croatia and Macedonia. As you may recall this operation was initially known as Operation Joint Endeavor and has changed names several times over the years. Service Members in a geographical area designated as a QHDA are not affected by the change of the name of the operation.

Tax relief is extended to Service Members in a QHDA if they are receiving hostile fire or imminent danger pay. It is important to note that each designated country will lose its status as a QHDA when the Department of Defense stops paying members either imminent danger or hostile fire pay for service in that country.

Regardless of whether you serve in a CZ or a QHDA, your tax benefits under the Internal Revenue Code are the same.

Other Locations Certified by the Department of Defense for
Combat Zone Tax Benefits 

Generally, to receive CZ/QHDA tax benefits, a member must serve in a CZ/QHDA during the period of time specified in the Executive Order or law. In some instances, however, Service Members outside of a CZ/QHDA may also receive CZ tax benefits when their service directly supports military operations in the CZ/QHDA.

The Department of Defense has certified the following locations for CZ/QHDA tax benefits due to their direct support of military operations, during the dates listed below:

In support of Operation Enduring Freedom (Afghanistan combat zone):

• Pakistan, Tajikistan and Jordan - Sept. 19, 2001
• Incirlik Air Base, Turkey - Sept. 21, 2001 through Dec. 31, 2005
• Kyrgyzstan and Uzbekistan - Oct. 1, 2001
• Philippines (only troops with orders referencing Operation Enduring Freedom) - Jan. 9, 2002
• Yemen - Apr. 10, 2002
• Djibouti - July 1, 2002
• Somalia - Jan. 1, 2004
• In support of Operation Iraqi Freedom (Arabian Peninsula / Persian Gulf areas combat zone):
• Turkey - Jan. 1, 2003 through Dec. 31, 2005
• Israel - Jan. 1 through July 31, 2003
• The Mediterranean Sea east of 30¡ East longitude - Mar. 19 through July 31, 2003
• Jordan - Mar. 19, 2003
• Egypt - Mar. 19 through Apr. 20, 2003

Income Earned while in a CZ/ QHDA may be Excluded from Gross Income

Enlisted Soldiers and warrant officers may exclude from their gross income all active duty pay, imminent danger/hostile fire pay and re-enlistment bonuses earned during the months spent in a CZ/QHDA. Commissioned officers may exclude up to the highest rate of basic pay for the most senior enlisted member of the Armed Forces, plus the amount of hostile fire or imminent danger pay for each month.

You are considered to be serving in a CZ/QHDA if you are either assigned on official temporary duty to a CZ/QHDA or you qualify for hostile fire/imminent danger pay while in a CZ/QHDA. If you spend a single qualifying day in the CZ/QHDA, your pay for the entire month is excluded from taxable income.

Service in a CZ/QHDA includes any periods you are absent from duty because of sickness, wounds, or leave. If, as a result of serving in a CZ/QHDA a person becomes a prisoner of war or is missing in action, that person is considered to be serving in the CZ/QHDA so long as he or she keeps the status for military pay purposes.

You do not actually need to show the exclusion on your tax return because income that qualifies for the exclusion should not be included in the wages report on your Form W-2. Also, you do not have to receive the excluded pay while you are in the CZ/QHDA so long as you earned it during the period you served in the CZ/QHDA. Service Members should carefully check their W-2s to ensure they are accurate. If your find an error, work through your unit finance officer to get the W-2 corrected.

Service Members serving in a CZ/QHDA have the option of including their non-taxable combat pay on their income tax return if it helps their eligibility for the 2008 economic stimulus payment. To receive the stimulus payment this year, CZ/QHDA personnel or their spouses must have filed a 2007 income tax return by 15 October 2008. Otherwise, they can claim the economic stimulus payment on next year’s income tax return. A taxpayer must have at least $3,000 in qualifying income to receive a stimulus payment.

What about State Tax Benefits for CZ/ QHDA participants?

Most states follow the federal government’s lead in granting some form of tax relief for Service Members serving in a CZ/QHDA. However, the manner in which the various states reach that determination, the amount of exclusion, and the amount of time extended to handle tax matters and file tax returns, varies from state to state. It is best to check with your individual state well in advance of any deadlines to see if you are entitled to additional benefits resulting from your military service.

Other Tax Benefits for Service Members

Service Members serving in a CZ/QHDA are entitled to a filing extension of 180 days plus the number of days the Service Member was in the CZ/HQDA during the normal tax-filing period (1 January through 15 April). The extension begins on the day after the Service Member leaves the CZ/QHDA. Service Members who use this extension will not be charged interest on the amounts owed to the Internal Revenue Service (IRS), and will receive interest from the IRS if they are entitled to a refund.

For example, 1 March 2007 you arrived in a combat zone without having filed your 2006 taxes. You returned to the United States on 1 January 2008. You are entitled to a 226-day extension for filing those 2006 taxes resulting in a deadline of 15 August 2008. This extension would apply to the filing and paying of your income taxes that would have been due 15 April 2007. In addition to the 180 day extension you received for being in a CZ, your extension period also includes the 46 days that were left before the April 15th deadline when you entered the combat zone. During this 226-day extension period, assessment and collection deadlines will be extended, and you will not be charged interest or penalties attributable to the extension period.

Service Members who qualify for this extension must clearly write in red ink “Combat Zone Taxpayer” across the top of their tax return and include their deployment date(s). You can also notify the IRS directly of your status through a special e-mail address: combatzone@irs.gov. You will need to provide the IRS with your name, stateside address, date of birth and date of deployment to the combat zone. You should NOT include any social security numbers in your e-mail. You, your spouse, or an authorized agent or representative can make this notification. The IRS cannot provide tax account information by e-mail so they will send responses to any questions about your account by regular mail to the address they have on record for you, within two business days. The IRS will provide answers to general questions regarding extensions for Service Members serving in a CZ/QHDA via e-mail.

Service members who qualify for extensions of time to file federal tax returns pursuant to the CZ/QHDA extensions can file their returns in accordance with the filing extensions previously mentioned. Service Members may also elect to file their returns before the end of the extension period. One way to file your tax returns while serving in a CZ/QHDA is to execute a special power of attorney, a general power of attorney, or the IRS Form 2848 (Power of Attorney and Declaration of Representative), appointing someone else to file your tax returns in your absence. When an attorney-in-fact executes a tax return pursuant to a power of attorney he/she must attach a copy of the power of attorney to the tax return. Remember that you are ultimately responsible for the accuracy of your tax return even if it is prepared and/or executed by another on your behalf.

- Extensions of Time for other Tax Actions

In general, the deadlines for performing certain tax actions are extended for the period of a Service Member’s service in a combat zone, plus 180 days after his last day in the combat zone. In addition to Federal Income Tax returns mentioned above, this extension applies to all tax schedules and forms that are attachments to the federal individual tax return, quarterly returns and child care schedules. Spouses of service members entitled to the CZ/QHDA tax benefits are entitled to the same suspension of time for handling tax matters.

If you were on a payment plan with the IRS for back income taxes before you entered a CZ/QHDA you should not have to make payments on the past due taxes for the period of time in which you are serving in a CZ/QHDA. However, you or someone on your behalf must contact the IRS office where the payments were being made to ensure that the IRS is on notice of your service in a CZ/QHDA.

If you were hospitalized because of an injury received in CZ/QHDA, then you are entitled to additional time to file your tax return. The extension of time encompasses the period of service in the CZ/QHDA, as well as any time of continuous qualified hospitalization resulting from injury received in the CZ/QHDA and the next 180 days thereafter.

The CZ/QHDA extensions also apply to civilian individuals serving in the CZ/QHDA in support of the U.S. Armed Forces. These include Red Cross personnel, accredited correspondents, and civilians acting under the direction of the U.S. Armed Forces in support of those forces (both Department of Defense civilian employees and civilian employees of defense contractors).

-IRA Contributions

The Heroes Earned Retirement Opportunities (HERO) Act (signed 29 May 2006) addresses the problem of Service Members serving in CZ/QHDAs losing the opportunity to contribute to IRAs. The HERO Act amends the IRS Code to include CZ/QHDA tax excluded income for purposes of eligibility for IRA contributions. The Act made the IRA contribution opportunity retroactive to tax year 2004. Thus, a Service Member who served in the CZ/QHDA during 2004 or 2005 has three years (until 28 May 2009) to make a contribution to an IRA for those tax years. The IRA contribution limit in 2004 was $3,000 and 2005 it was $4,000. Anyone over age 50 in those years can contribute the $500 catch-up amount as well.

Contributions to a Roth IRA need not be reported. However, contributions to a traditional IRA must be reported on the appropriate year’s tax return. Some Service Members will need to file an amended tax return if they’d already filed for that tax year and some will just need to file the form 8606. IRS Publication 590, Individual Retirement Arrangements is a good resource for additional information on this benefit.

Conclusion 

Regardless of whether you handle your own tax matters or hire someone to do it for you make sure you understand your entitlements and obligations. If you have questions you can go to the Internal Revenue Service’s web site at www.irs.gov. Under the “Individual” icon, you can select “Military” to find rules, notices and publications. You will find most of the rules pertaining to military service in IRS Publication 3, Armed Forces Tax Guide. Remember that you are responsible for what is on your tax return, no matter who prepares it.