Military Tax Deductions & Exemptions
Military service demands sacrifices — some personal, some financial. But in many cases, Uncle Sam recognizes those hardships and offers special privileges to compensate. When it comes to paying taxes, for example, military members can claim a host of tax advantages that aren’t available to civilians. Here are a few to keep in mind:
Combat Pay Perks
Freedom from Taxes
If you serve in a combat zone as an enlisted service member or as a warrant officer for any part of a month, all your income for that month is exempt from federal taxes. For officers, the monthly exclusion is capped at the highest rate of enlisted pay, plus any hostile fire or imminent danger pay received. You’ll find a list of the geographic areas considered tax-qualified combat zones on the IRS website.
Potential for Savings
Tax-free pay can provide a great opportunity to save extra money or reduce debt. In fact, IRS rules allow tax-free combat pay to be used for contributions to an IRA. Since your IRA can grow tax-deferred until you withdraw the money, contributing more today can provide a real savings boost over the years.
And if you choose a Roth IRA, you can do something even more beneficial: You can turn your tax-free pay into a source of potentially tax-free withdrawals in retirement, because qualified distributions of earnings are not taxed.
You can make a 2012 IRA contribution up to $5,000 ($6,000 if you were 50 or older by Dec. 31), along with a spousal IRA contribution, until the April 15, 2013, tax filing deadline, plus any applicable extensions. In 2013, annual contribution limits are rising to $5,500. Individuals who will be 50 or older on the last day of 2013 can contribute $6,500.
Your combat-zone service also entitles you to a special perk within your federal Thrift Savings Plan. While annual contributions are normally limited to $17,000 in 2012 and $17,500 in 2013, you may invest as much as $50,000 when serving in a combat zone in 2012 and $51,000 in 2013. The dollars that go into your TSP tax-free also come out tax-free — though you will owe tax on any earnings you make on those dollars.
Exceptions to the Rules
Extra Time at Tax Time
When you’re defending our country, your tax return is probably the last thing on your mind. You can’t put off filing taxes forever, but you and your spouse may qualify for a deadline extension of at least 180 days after you’ve returned from a combat zone.
Extensions apply to several actions, including:
- Filing returns
- Paying taxes
- Making claims for refunds
- Contributing to IRAs
State Tax Flexibility for Spouses
Before 2009, military spouses generally had to pay income taxes to the states where their spouses were stationed — but now they have a choice. Under the Military Spouses Residency Relief Act, military spouses can choose to be treated as if they still lived in their previous state. That could generate big savings if their previous state has lower tax rates — or no income tax at all. But that’s not all: If they had income tax withheld in the state they’re living in, they may get a refund by filing a return in that state.
Generally, joint returns must be signed by both spouses. However, if your duties keep you away from home, your spouse can use a power of attorney to file a joint return on your behalf.
A Break When Selling Your Home
Taxpayers, whether civilian or military, can generally sidestep paying capital gains taxes on the sale of their home if they owned it and used it as their qualifying principal residence for two out of the five years preceding the sale. This rule can be used to exclude up to $250,000 in gains for individuals or $500,000 for married couples.
Military service members get some extra help when it comes to satisfying the two-out-of-five-years test. They’re allowed to suspend the five-year test period for up to 10 years when they’re on qualified extended duty — that is, assigned to a duty station that’s at least 50 miles from the house for a period of 90 days or more. In effect, they can disregard the time they were ordered away from their home. The rules concerning this get a little tricky; learn more at the IRS website and consult a professional tax advisor.
Help With Expenses
Moving every few years gets expensive for active-duty members. But if your move is a required permanent change of station, the IRS allows you to deduct the “reasonable unreimbursed expenses” of relocating yourself and your family.
If you’re transitioning back to civilian life, you may be able to deduct some of the costs you incur while looking for a new job. Qualified expenses may include:
- Resume preparation fees
- Outplacement agency fees
Moving expenses may be deductible if your relocation is closely related to the start of work at a new job site and if you meet certain requirements.
Breaks for National Guard and Reserves
If you’re called more than 100 miles away from home to perform Reserve duties, you can generally deduct any unreimbursed travel expenses.
If you are prohibited from wearing certain uniforms when off duty (a rule that usually applies to reservists), you can generally deduct the cost to buy and maintain those uniforms. But you must reduce your expenses by the amount of any uniform allowance or reimbursement you receive.
A call to active duty sometimes creates financial hardship for reservists whose military income is much lower than their civilian pay. If a cash crunch causes you to take money from your IRA, 401(k) or certain other retirement plans, the IRS may waive the 10% penalty tax normally applied for withdrawals before age 59½. You’ll still be subject to income tax on the distribution, but without the extra sting of the penalty.
Free Tax Assistance
Most military installations offer tax help to service members and their families through the Volunteer Income Tax Assistance Program. VITA’s certified community volunteers are trained by the Internal Revenue Service and understand military-specific tax issues. Best of all, their advice and tax preparation services won’t cost you a penny.
For complete details, download IRS Publication 3, Armed Forces’ Tax Guide, which summarizes many important military-related tax topics. Publication 3 may also be ordered by calling 1-800-TAX-FORM (800-829-3676).