GIs in Gulf Can Get Special Breaks That May Boost Refunds

In normal times, taxes are unaffected by the type of job you hold. But today, if you are in the military and are serving in the Persian Gulf, you get special treatment that will probably result in a higher tax refund.

Military personnel on duty in the combat zone may be able to exclude a significant portion of their income from taxes. They won’t be charged interest or penalties if they owe money and fail to file before April 15. And if the Internal Revenue Service owes them money, interest on that refund will start to accrue April 15 at a generous rate--no matter when the return is filed.

“If somebody owes money, there is no reason to file because you don’t have to pay interest or tax until six months after you return,” said R. Michael Shaw, partner with the accounting firm Coopers & Lybrand in Los Angeles. “If you’ve got the money, put it in the bank and earn interest on it.”

Military personnel and their spouses should make sure that they don’t spend the money they’ve set aside to pay taxes though. The tax bill is not forgiven, just delayed.

All other tax problems--such as audits or claims of deficiency from previous years--will also be put on hold, if military members notify the IRS that they are involved in the Gulf War. All they need to do is write “Desert Storm” on the envelope and the notice, and send it back. The IRS will drop the case until six months after the service member returns home.

The IRS has also pledged to expedite refunds due service members and their spouses when they mark “Desert Storm” on the envelope and tax return.

A refund is more likely than ever, because Congress passed a law that excludes at least some portion of the service member’s pay from federal tax while he or she is working in the war zone. Officers may exclude up to $500 a month from taxes while serving in the combat area--which includes Iraq, Kuwait, Saudi Arabia, Oman, Bahrain, Qatar, the United Arab Emirates and nearby Gulf regions. Those who are not officers may exclude their entire paycheck from federal taxes while in the combat zone.

Congressional staffers said the new rules were passed to show support for the men and women who had to leave their families and friends to serve in the Gulf. Congress was also aware that many service members were called to duty quite suddenly and might not have been able to get their financial affairs in order before leaving the United States.

However, Congress did not grant tax breaks to thousands of military members and reservists who were called to duty in other parts of the world. The Gulf operation forced the United States virtually to empty many foreign and domestic military installations--bases in the Philippines, for example--which were then restaffed with reservists and military personnel from other areas.

If service members are not in the combat zone, they do not get the special tax breaks.

The combat zone tax rules can affect the military family’s 1990 return and their tax planning strategies for 1991, Shaw said. A couple of hypothetical examples illustrate the point.

John Jones is a military officer who has served in Saudi Arabia since Sept. 1. He is married and has two children. The family’s combined income is $50,000. They own a home, which helps give them $10,000 in itemized deductions.

Because he was in the combat zone for four months of 1990, he is able to exclude $2,000 of his income from taxes. (That’s the officer’s rate of $500 a month times four.)

After deducting standard exemptions of $8,200 and itemized deductions of $10,000, this family’s taxable income is $31,800. Normally, their federal tax would be $4,774. However, this year they are able to exclude $2,000 that John earned while serving in the Gulf. That cuts their income to $29,800 and their tax to $4,474, for a $300 tax savings.

The income exclusions benefit non-officers even more.

Consider a similarly situated enlisted man--Sam Smith--whose military pay is $27,000 annually, or $2,250 a month. Household income is $50,000 for a family of four, and the Smiths also have $10,000 in itemized deductions.

Sam Smith has served side by side with John Jones, starting Sept. 1 in the Persian Gulf. In a normal year, the Smiths would pay exactly the same tax as the Jones family. However, this year Sam Smith is able to exclude four months’ income, or $9,000, from tax.

After accounting for itemized deductions and personal exemptions, that cuts the Smith family income to $22,800 from $31,800. Their tax liability plunges to $3,424 from $4,774. Total savings: $1,350.

Assuming the Smiths had 15% of their $50,000 income withheld by their employers during the year, they would be due a $4,076 refund ($7,500 withholding minus tax liability of $3,424).

The Smiths might want to file their return quickly to get the cash. But, if that is inconvenient, they can wait until six months after Sam returns home. The IRS will pay them interest on their refund, starting April 15.

The interest rate can vary, but currently the IRS pays 10% annually, a healthy rate of return. So, those who don’t need the money right away are not losing much by filing late.

If the Smiths’ withholding was insufficient to cover their tax liability, they could also delay filing their return. The IRS says it will assess no late filing penalty nor charge interest to service members who file within six months of their return home. Again, just mark “Desert Storm” on the return and envelope to notify the agency of your special filing status.

Planning can also be affected by Desert Storm, tax experts note.

Those who expect to be stationed in the combat zone for several months in 1991, for example, might want to reduce their withholding, since their 1991 tax will be reduced by these special combat zone tax rules.

However, once the military member leaves the combat zone, withholding should be increased again to avoid owing the IRS a substantial sum next April.

TWO MILITARY FAMILIES John Jones and Sam Smith are two hypothetical military men in families of four. Their filing status is nearly identical. Each family earns $50,000 annually, has $10,000 in itemized deductions and four personal exemptions. Both Smith and Jones were in the Persian Gulf for four months last year. The one difference: Jones is an officer, while Smith is an enlisted man. That means Smith will pay significantly less tax because he can exclude all of his military pay of $9,000 for the four-month period, while Jones can exclude only $500 a month, or a total of $2,000.

Jones family Smith family Earned income: $50,000 $50,000 Personal exemptions: 8,200 8,200 Itemized deductions: 10,000 10,000 Military exclusion: 2,000 9,000 Taxable income: 29,800 22,800 Tax: 4,474 3,424