Unlocking Tax Advantages for Military Clients: Credits, Combat Pay & More

 

Taxes are tough enough for civilian taxpayers, but our military personnel and their families face extra challenges that take tax preparation and planning to another level. A member of the military often works in an entirely different environment than a civilian employee, with frequent relocations often spanning multiple states, deployments taking them away from their “home base” for months at a time, and in many cases being constantly on-call that makes year-round tax planning nearly impossible. 

The IRS and state tax authorities have implemented special provisions and exemptions that acknowledge the demands of military life and the sacrifices made by our service people. As a professional tax preparer, you should be aware of these provisions and specialized resources as you advise your clients in the military.

Deployment Income

One aspect of military service that affects taxation is deployment. When service members are deployed to a combat zone or a qualified hazardous duty area, they may be eligible for certain tax benefits.

A significant one is the combat zone exclusion, which means that some or all pay earned in these zones may be exempt from federal income tax. For enlisted personnel, all pay received during active service in a combat zone is generally excluded. For officers, there's a monthly cap on the excluded amount, which is equivalent to the highest rate of basic pay for enlisted personnel, plus any hostile fire or imminent danger pay received.

It's important for service people to keep accurate records of deployment dates and locations, as this information is essential when filing taxes. Keep in mind, the deadline to file and pay federal income taxes is automatically extended for service members serving in a combat zone or contingency operation. This extension generally lasts for 180 days after they leave the combat zone or contingency operation, plus the number of days remaining in the original filing period.

Military Members and Residency

Residency for tax purposes can be a complex issue for military personnel who frequently move due to their service. Generally, the taxpayer’s state of legal residence (domicile) is where they were a resident when they entered military service and where they intend to return. This state retains the right to tax the service person’s income, regardless of where they are stationed. However, the Service Members Civil Relief Act (SCRA) provides certain protections for active duty military members. For instance, if a member of the military has legal residence in one state but is stationed in another due to military orders, the state where they are stationed cannot tax their military income. They may still be subject to taxes on income earned from sources within that state other than their military pay. It's crucial to understand the residency rules of the service member’s home state and any state where they might earn non-military income. Your client might need to file a nonresident tax return in the state where they are stationed if they have income from sources within that state.

Military Spouses Residency Relief Act (MSRRA)

The Military Spouses Residency Relief Act (MSRRA) amended the SCRA to extend significant tax benefits to spouses of active-duty service members. Under MSRRA, a military spouse can maintain their state of legal residence even if they move to a different state to accompany their service member spouse. This means the spouse can choose to pay taxes and vote in their home state rather than the state they currently reside in due to military orders. Additionally, the Veterans Benefits and Transition Act of 2018 allows spouses to elect their service member's state of legal residence for tax purposes, regardless of when their marriage occurred.

Tax Forms for Military Personnel

Generally, military personnel file with the same tax forms used by civilians. The basic form for most individuals is Form 1040, U.S. Individual Income Tax Return. If the taxpayer has a combat pay exclusion, this will be reflected on their Form W-2, Wage and Tax Statement, usually in Box 12 with code Q. They may also need to file Schedule 1 (Form 1040), Additional Income and Adjustments to Income, and other schedules depending on their specific financial situation, such as if they have itemized deductions (Schedule A) or business income (Schedule C).

Leave and Earnings Statement (LES) 

Military personnel and civilian employees of the military receive a Leave and Earnings Statement (LES). The LES is a useful document for a tax preparer and details the service person’s pay, deductions, and other financial information. Service members can access their LES through the Defense Finance and Accounting Service (DFAS) myPay system. 

Tax Credits and Deductions for Military Families

Military members and their families may be eligible for various tax credits and deductions. For example, the Earned Income Tax Credit (EITC) is a refundable tax credit that may benefit lower-income individuals and families, including military families. The Child Tax Credit and Credit for Other Dependents can also provide significant tax relief. Additionally, service members may be able to deduct certain unreimbursed moving expenses if they are moving due to a permanent change of station (PCS). This is an above-the-line deduction, meaning the taxpayer doesn’t have to itemize to claim it. Reservists and National Guard members who travel more than 100 miles away from home to perform their duties may be able to deduct their unreimbursed travel expenses.

Specialized Resources for Military Taxpayers

Recognizing the unique challenges faced by military personnel, several specialized resources are available to help with tax preparation. The Armed Forces Tax Assistance (AFTA) program provides free tax information and assistance to military members and their families worldwide. Military OneSource also offers tax consultations and e-filing software at no cost to eligible service members and their families.

The Volunteer Income Tax Assistance (VITA) program, available on some military installations and in surrounding communities, offers free tax help to eligible taxpayers, including military members. Tax Counseling for the Elderly (TCE) is another program that can assist, particularly with military-related pension and retirement-related issues.

California Taxes and Military Service

For service members stationed in California or who are legal residents of California, it's important to understand the state's tax regulations regarding military income. California generally does not tax the military pay of nonresident service members stationed in the state due to military orders, thanks to the SCRA. However, if California is the client’s state of legal residence, their military income is generally taxable by California, regardless of where they are stationed. There are some exceptions, such as the previously mentioned combat pay exclusions, which often align with federal exclusions. The client will likely need to file California Form 540, California Resident Income Tax Return, if they are a resident, or Form 540NR, California Nonresident or Part-Year Resident Income Tax Return, if they are a nonresident with California-source income.

Support Your Clients in the Military and Their Families

Income tax preparation for service members requires awareness of deployment-related benefits, residency rules, relevant tax forms, available credits and deductions, and an understanding of how a service member’s situation differs from that of a civilian taxpayer. With a solid working knowledge of the special tax situations faced by members of the military and the assistance programs and resources available for this unique and important community, you can provide valuable, professional tax advice to your military clients.

Resources

Publication 3, Armed Forces' Tax Guide - IRS

Tax Information for Members of the Military - IRS

Military Spouses Residency Relief Act - Military OneSource

Combat zones approved for tax benefits - IRS

Tax exclusion for combat service - IRS

Extensions and tax return preparation assistance for military personnel - IRS