When it comes to serving in combat zones, it's important for military members to be aware of the different tax rules that apply to them, including new rules on what qualifies as taxable income and even the date when a tax return is due.
A servicemember is considered to be serving in a combat zone if he or she is stationed on temporary duty in a combat zone or qualifies for hostile fire or imminent danger pay while in a combat zone. Additionally, some members of the Armed Forces may have qualifying service while stationed outside of a combat zone. A list of current combat zones designated by the U.S. Government can be found in IRS Publication 3, Armed Forces' Tax Guide.
In regards to determining taxable income, members of the military should remember that any income earned for services performed while in a combat zone is considered to be combat pay and is therefore not taxable and is not considered earned income. Combat pay is reported in Box 12 (code "Q") of Form W-2, Wage and Tax Statement (not Box 1). If you serve in a combat zone for any part of one or more days during a particular month, you are entitled to an exclusion of income for that entire month.
Editor's Note: For officers, federal and state wages are excluded from taxes, up to an amount equal to the monthly basic pay rate of the senior enlisted member for each branch of service, plus Hostile Fire/Imminent Danger Pay if authorized for the period.
Servicemembers who are activated for extended periods of time in combat zones may find that they have little or no earned income when calculating certain credits and deductions. The Earned Income Tax Credit (EITC), the Additional Child Tax Credit, and the ability to contribute to an IRA all require the taxpayer to have earned income. By including their combat pay in the computations to determine these benefits, military taxpayers have a unique opportunity to decrease their tax liability and often increase the amount of a tax refund.
EITC is a refundable tax credit for eligible taxpayers who work and have earned income under a certain amount. By reducing the amount of tax owed, the EITC often produces a refund for the taxpayer. Members of the Armed Forces who have combat pay can choose to include that pay in the EITC calculation to receive a larger refund.
Another advantage, the Additional Child Credit, is a refundable tax credit for taxpayers with children who are not eligible for the full child tax credit. Taxpayers must include their non-taxable combat pay with earned income in order to calculate this credit. Being able to include combat pay in the credit calculations often provides taxpayers with a greater refund.
The Heroes Earned Retirement Opportunities Act (HERO Act), also provides military taxpayers with additional tax benefits. Under the HERO Act, combat pay can now be considered compensation for purposes of determining any allowable IRA contributions. Generally, the allowable IRA contribution each year is limited to the lesser of $5,500 ($6,500 if age 50 or older) or the individual's total taxable compensation for the year.
Finally, taxpayers who are overseas on the tax deadline day (traditionally April 15th) can receive an automatic two-month extension to file their tax return. For servicemembers located in a combat zone, the extension of time to file is even greater: It is 180 days after leaving the combat zone, plus the number of days the servicemember had left to take action with the IRS when entering the combat zone. For example, Jim enters a combat zone on April 10th, five days before the tax filing deadline of April 15th. Upon leaving the combat zone, he will have 185 days to file a tax return (180-day automatic extension plus five days left in the tax filing season when he entered the combat zone). Note that this deadline extension applies to the deadline for filing a tax return, paying any tax liability due, and claiming a tax refund.
Military taxpayers should consult with a tax preparer, such as those at Jackson Hewitt Tax Service, to understand all of the tax implications associated with combat pay. For the nearest Jackson Hewitt location, call 1-800-234-1040.
Resources: IRS Publications 3,17, 596; Form 8812 instructions