More than 500,000 men and women in the U.S. armed forces will get some extra benefits this tax season, thanks to laws passed in the wake of military actions in Afghanistan and Iraq.
A key change, approved by Congress last year, gives members of the military the option to include or exclude all the pay they receive while serving in a combat zone when computing credits based on taxable income -- whichever will save them the most money.
Most combat zone pay is exempt from federal income tax. But until recently, that exemption could also end up disqualifying service members from claiming the earned-income tax credit -- a break of as much as $4,300 in taxes for individuals and families earning less than $35,458 annually.
That’s because to qualify for the credit, individuals or households must have taxable income. For example, a soldier who spent all year in a combat zone -- and had no taxable income -- would not be eligible. For a soldier who has two children and makes $30,000 a year, the loss of that credit would cost $944.
On the other hand, a soldier who earned half of his or her $30,000 in a war zone would definitely want to exclude that pay, because that would make the soldier eligible for the full earned-income credit of $4,300. (The credit is staggered based on income. Those earning about $15,000 annually get the biggest credit, whereas those earning less or more get less. That’s because the credit was initially aimed at returning Social Security taxes to low-income filers.)
“You have to study the effect before you decide what to do,” said Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.-based tax information and research service. “There’s a range where additional income can help you and a range where it can hurt you.”
The pay provision affects 565,809 active and reserve service members who served in hostile areas on land or sea in 2004, Defense Department spokeswoman Ellen Krenke said.
Spending any amount of time -- even a day -- in a combat zone, a “qualified hazardous-duty area” or a “direct support area” qualifies the individual to exclude that full month’s worth of pay, Krenke added. In other words, someone who arrived in a combat zone Jan. 31 and left Feb. 1 could exclude two months of pay.
The Internal Revenue Service maintains a list of combat zones and hazardous-duty areas on its website at www.irs.gov.
Other tax breaks for the military:
* Those serving in combat zones, deployed in “contingency operations” or hospitalized outside the United States as the result of injuries sustained while deployed don’t have to file tax returns until 180 days after they return home. No interest or penalties will be assessed on those who owe tax. They simply should write “combat zone” at the top of the return when they do file. However, those who are due refunds may want to file sooner, because no interest is paid on the refund either.
* There’s a total tax exemption for those who die as the result of wounds, disease or injuries incurred in a combat zone. All the service member’s income -- not just military pay -- is exempt from tax going back to the first year of service in a combat zone. If a service member was stationed in Iraq in 2003 but died in 2004, his or her family could claim a tax refund for any taxes paid in both years, Luscombe said. In 2004, 738 service members died in Iraq and Afghanistan, Krenke said.
* The value of benefits afforded military families, such as paid child care and dependent-care assistance, is excluded from income.
* Members of the reserve and National Guard can take a deduction for service-related travel expenses when they need to travel overnight more than 100 miles from home. The deduction, which can be taken even by those who don’t itemize, is limited to the federal per diem rate, which varies by locality.
* Free tax filing help is offered on most military bases, Krenke said.
Kathy M. Kristof, author of “Investing 101" and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail firstname.lastname@example.org. For previous columns, visit latimes.com/kristof.