International Taxation Issues Affecting Military Returns

From all of us at Tax School, we want to wish all who have served a very happy Veterans Day. For those of you with clients currently serving in any branch of the military, there are some unique taxation issues worth noting. We will explore some of these issues, particularly the ones that relate to international taxation. If you’re looking for more information on this topic and other international issues, consider registering for our International Tax Issues Affecting Form 1040 Filings webinar.

Combat Pay

For U.S. tax purposes, military pay is generally taxed as compensation, and other allowances and benefits may or may not be includable in income. Pay earned by a service member while on duty in a combat zone or qualified hazardous duty area may be excluded from income. Service members below the grade of commissioned officer can fully exclude such pay for each month or partial month of active duty in the combat zone or qualified hazardous duty area. The excludable amount for commissioned officers, however, is limited to the maximum enlisted amount which is the sum of:

• • The highest rate of basic monthly pay at the highest pay grade for any enlisted member, and
  • Any amount of hostile fire or imminent danger pay that the officer is entitled to for the month.

A commissioned warrant officer is not considered a commissioned officer under this rule.

Note. See IRS Pub. 3, Armed Forces’ Tax Guide, for more information on the combat pay exclusion, including how a combat zone is designated, and when service outside such a zone may still qualify as combat zone service. Current combat zones, which include areas in the Sinea Peninsula, Afghanistan, Kosovo, and Arabian Peninsula, are identified at www.irs.gov/individuals/military/combat-zones.

Special EIC Election

Even though combat pay is excluded for income tax purposes, the servicemember may elect to include combat pay as part of earned income for the year for earned income credit (EIC) purposes. All nontaxable combat pay received in the year must be treated as earned income under this election. Spouses who each receive combat pay may make their own individual election.

Note. Treating nontaxable combat pay as earned income for EIC purposes can have the effect of either increasing or decreasing the taxpayer’s EIC. Dual calculations should always be completed to determinewhether it is beneficial to make the election.

Combat Pay and the Child Tax Credit

Nontaxable combat pay is included as earned income for purposes of computing the child tax credit. IRS Pub. 3 describes the application of the child tax credit, the credit for other dependents, and the additional child tax credit in detail.

Qualified Military Benefits

Military personnel receive numerous benefits or allowances in connection with housing or living expenses that may be excludable from gross income. Examples of excludable benefits or payments shown in IRS Pub. 3 include the following.

• • Basic allowances for housing or subsistence
  • Overseas housing allowance
  • Dislocation allowance
  • Move-in housing
  • Allowances for moving or storage of household or personal items
  • Temporary lodging allowance

Filing Deadlines

The normal April 15 filing deadline for military personnel is extended by at least 180 days beyond any of the following periods, if applicable.

• • Any period of service in a combat zone
  • Any period of hospitalization outside the U. S. because of combat zone service
  • Any period of hospitalization in the U. S. due to combat zone service, up to a maximum of 5 years

Note. This filing extension applies to the filing of tax returns, the payment of income tax, and the filing of a claim for refund or credit.

The spouse of a combat zone servicemember is also granted an extension. The spousal extension, however, does not apply to tax years beginning more than 2 years after the date that combat ceased in the zone where the servicemember was stationed. The period of U.S. hospitalization of the servicemember does not add to the spousal extension.

Remember, if you’re looking for more information on this topic and other international issues, consider registering for our International Tax Issues Affecting Form 1040 Filings webinar.

By Kelly Golish,  CPA
University of Illinois Tax School
Assistant Director, Tax Materials

Resources:

IRS Pub. 3, Armed Forces’ Tax Guide

IRC §§112, 32(c)(2)(B)(vi), 24(d), 7508

Treas. Reg. §1.112