31 Mar How to Make Your Military Taxes Ready
Military taxes are income tax with a military twist. There are “special rules” afforded to those in uniform regarding taxes. But do you know what they are and how to apply them? Your unique tax situation can influence other areas of your life. From what kind of retirement account you should invest in, to whether you should rent or sell your home when you PCS. Having a better understanding of how tax situations are treated during military service may improve your financial decision-making.
Military taxes are federal and state income tax filing for U.S. service members and their dependents. Military service comes with some special tax breaks and deductions that members of the armed forces can apply to their taxes.
Albert Einstein once said, “The hardest thing to understand in the world is the income tax.” So you’re not alone if you find your military taxes to be a dreaded choir. This article is intended to help you understand tax concepts, how to apply them, and where you can find free tax help to make your military taxes ready.
I’d like to start with a reminder that although I’ve stayed at a Holiday Inn Express many times, I am—in fact—not a tax professional. This article is a chance for you to read up on military taxes but if you have questions or need help with your taxes, consult a tax professional. Below you can find free and discounted tax resources for the military community.
Now that we got that “official” stuff out of the way let’s talk taxes.
Table of Contents
What Are Income Taxes?
It may seem basic, but that’s how I like to keep money. Often people aren’t clear on what exactly taxes are, so let’s start there. Taxes are money collected from you, by the government, for the government. And when I say government, that means both federal and state government (depending on your home of record). Income tax is one of the main types of taxes collected. Sales and property tax would be two others.
Income tax is progressive, meaning the more you make, the more you pay in taxes. As your income increases, so does your tax bracket. The income you’re taxed on isn’t just your salary. It includes wages and investment earnings like dividends and interest.
Why You Should Know About Military Taxes
It’s your income being taxed. That’s why you should care and be mindful of your taxes. You work hard and make sacrifices for the money you earn. Paying attention to the benefits afforded you as a service member can mean you can keep more of your earnings.
Don’t let the word “tax” scare you. Taxes just seem daunting because we don’t do them all the time. Before you read on, it will be helpful to look at a 1040, so you know where I’m starting and where I’m going. You don’t have to memorize it. Just look at it! It’s a piece of paper. It doesn’t bite—that’s the IRS.
Let’s take it from the top! When you look at your tax return, Form 1040, the gross income is located in box 1. The gross income is the total income you make in a year before taxes and other deductions. I like to remember gross income as “it’s gross how much money they’re getting ready to take out for taxes.”
Military Gross Income Exclusions
When you serve in the military, only part of your income is taxable because you receive some tax exclusions. Thus, when you file your taxes, it’ll look like you make less than you do. Some of the most common exclusions include:
- Combat Pay(exclusion for officers is limited)
- BAH (Basic Allowance for Housing)
- BAS (Basic Allowance for Subsistence)
- OHA (Overseas Housing Allowance)
- Dislocation Allowance
- Separation Allowance
- Per Diem
The pay included in your gross income includes you:
- Basic Pay
- Special Pay
- Bonus Pay
- Incentive Pay
When you’re deployed to an area designated as a combat zone for more than one day, your income earned during that period will be excluded from your income for tax purposes.
Enlisted and commissioned Warrant officers can exclude all of their income earned during service in a combat zone. When preparing a return for the tax year of 2020, officers can only exclude up to $9,069.30 per month from taxes. It’s broken down to $8,844.30 plus $225 for imminent danger pay. Anything above that amount will be taxable income.
Remember this. Allowances and combat pay are not taxable income. I like to point this out because it’s an area that comes to bite veterans later. It’s often forgotten that a good portion of your income on active duty isn’t taxed. So when it comes time to pay taxes after the military, it can be a shock because you’re often in a higher tax bracket.
You can find more information on what pay is excluded and included in your gross income in the Armed Forces Tax Guide.
Adjustments to Income
Adjustments to income reduce your gross income. Your adjusted gross income is your total taxable income after deductions and adjustments. Examples of adjustments would be alimony payments, student loan debt interest, and contributions to retirement accounts
Your adjustment calculations are done on separate forms. Then the values are brought back to your 1040. Here are some of the income adjustments for service members.
Travel Expenses For Reservists
When Reservists travel more than 100 miles away from their home for the performance of duties, any unreimbursed travel expenses may be deducted on their tax return. Items included are food, lodging, and mileage, but only if these items are unreimbursed.
If you’re moving due to a PCS, you may deduct certain moving expenses as long as you haven’t received reimbursement for them. Some of the items you may include are the expenses to move, store and insure your goods as well as travel.
For example, if you were a single service member PCSing with a car and a motorcycle. The military won’t reimburse you for the trailer to haul or ship your motorcycle to your new duty station.
Individual Retirement Accounts (IRA)
If you or your spouse contributed to a traditional IRA during the year, you might be able to deduct the total amount of the contribution. The amount you deduct depends on your income, whether one or both spouses were covered under an employer-maintained retirement plan (FYI, the TSP is an employer-maintained retirement plan).
Related: Spousal IRAS – What Military Spouse Should Know
A tax credit is a direct reduction in the taxes you owe. A tax credit will always trump a tax deduction because a tax deduction is not a dollar-for-dollar reduction.
There are two types of credits: refundable and nonrefundable. A refundable credit means that if you owe $0, you can get a tax refund of the credit amount. A nonrefundable credit means that the credit can only get the amount of taxes you owe down to $0. You won’t get a return of the credit amount. Some of the more common tax credits include:
Child Tax Credit & Credit for Other Dependent – The Child Tax Credit (CTC) is a partially-refundable credit for those who claim a qualifying child as a dependent. The maximum credit amount per child is $2,000 and $500 per qualifying dependent. To claim, you must file your tax Form 1040 and include the name and tax identification number (TIN) of each person you’re claiming.
Additional Child Tax Credit – The ACTC is a refundable credit for filers with three or more qualifying children.
Child & Dependent Care Credit – A nonrefundable credit for those who incur expenses for the care of children or other dependents so that they may work or look for work. The credit is a percentage of your adjusted gross income (AGI), between 20%-35%, up to $3,000 of expenses paid for one qualifying person, or $6,000 for more than one.
Earned Income Credit – A refundable credit up to $6,660 (2020) for working families with low to moderate-income.
Saver’s Tax Credit- A nonrefundable credit that encourages retirement savings. The credit amount is a percentage of your contribution (50%, 20%, 10%, 0%), and it’s based on your AGI.
American Opportunity Tax Credit (AOTC) & Lifetime Learning Credit (LLC) – The AOTC is a partially refundable credit for the qualified education expenses for those pursuing the first four years of higher education. The maximum credit amount one may receive annually is $2,500. The LLC is a more liberal, nonrefundable tax credit for education expenses. The instruction may be undergraduate, graduate, certificates, or individual classes.
State Taxes for Military
Home of Record Vs. Residence
Home of record versus your residence is a topic that is confusing to most in the military. It’s essential to understand the difference because confusing them could cost you money and a massive tax headache!
Home of Record or Domicile
Your home of record, A.K.A. your domicile, is (according to the IRS) “the permanent legal home you intend to use for an indefinite or unlimited period, and to which, when absent, you intend to return. It isn’t always where you presently live.”
It’s the place you joined or, in some cases, reenlisted in the military. If you’re still unsure about where your domicile is, you can refer to your LES and see box 44.
To contrast domicile, your residence is where you currently live, even though you may not be a resident of that state.
For example, if you join the military in Tennessee and your duty station is in California. Your LES still shows TN as the domicile state, and even though you live in CA. Your income wouldn’t be subject to CA state income tax. In fact, you won’t be subject to state income tax at all.
Related: How to Read a Military Leave and Earnings Statement (LES)
Military Spouse Residency Relief Act
The Military Spouse Residency Relief Act (MSRRA) was initially passed in 2009 and underwent a revision in 2018. The law was intended to “simplify” the tax filing for military families, where they would only need to file a tax return in one state.
The spouse’s income would only be taxable in the state of domicile, not the state where the income was earned. To be eligible for the MSRRA, the service member and spouse must be residents of the same state before getting married. The spouse must only be outside of their domicile state to live with their service member on orders. The requirement that both service members and their spouses needed to be from the same state excluded many military families from utilizing this well-intended Act.
The Veterans Benefits and Transitions Act of 2018 amended the MSRRA and now allows spouses to select the same state of residence as their spouse, even if they never lived there together! Be aware that a spouse may not arbitrarily choose a state without income tax if the service member has no ties to the state.
To claim the same state as a spouse, you will have to establish a presence, such as getting a driver’s license, registering to vote. If the spouses voluntarily live in separate states, the MSRRA/VBTA does not apply.
Do Military Pay State Taxes?
The answer is, it depends. Nine states do not have a state income tax. This means if you live in a state that does not require a state return, you only have to file a federal tax return. The states with no state income tax are:
- South Dakota
- New Hampshire*
*New Hampshire and Tennessee do not tax earned income but do tax investment income such as interest and dividends. Based on your unique situation, you may need to file a state tax return if you’re an NH or TN resident.
There are many nuances to how and if income gets taxes for military personnel.
Multiple State Filings
When it comes to filing state taxes, the general rule of thumb is that you need to file a return in each state you lived and earned income in throughout the year. For service members, that could get complicated quickly!
Fortunately, unless you have earned income through other jobs, you only need to file in your home of record, no matter how many states you lived in throughout the year. If you married and your spouse works, the MSRRA eliminates the need to file in multiple states.
If the spouse does not invoke the MSRRA and claims the same domicile state as the service member, you may have to file multiple state returns. In that case, the spouse would need to file a return in the states where they earned their income.
Rental Property Income
When you own rental properties, your tax return complexity increases, especially since the properties are often outside of your state of domicile. You can get more details from the IRS Publication on Residential Rental Property here.
Know that the IRS classifies rental real estate in three ways, but I’m going to focus on primary use rental activity for this article. Primary use rental property is a home you may have once resided in, but you have PCSed and have no intent on moving back in the immediate future or purchased to rent out.
The income received through rental activities is taxable. Security deposits are not included as income unless you keep all or part of the deposit. You may take deductions against the income through ordinary and necessary expenses that may include, but are not limited to:
- Repairs (not upgrades)
- Property management & advertising
- Insurance, taxes, HOA fees, utilities
- Legal and professional fees
- Auto and travel
The important thing to remember here is that you need to keep detailed records!
When it is time to file your tax return, you’ll typically need to file a nonresident state income tax return in each state you own a property (if you do not live there). You’ll also need to include the rental income on the domiciliary state return. This may trigger state taxes because the Servicemember’s Civil Relief Act generally covers your military income and not income derived from other means.
Selling A Home
As if selling a home weren’t stressful enough, you also need to be aware of the tax consequences that can result. Generally, the rule is that you can exclude up to $250,000 (S)/$500,000 (MFJ) of capital gains from taxation if you owned the home for at least two years (the ownership test) and lived in the house as your primary residence (use test) for at least two years.
The time does not need to be concurrent. As you can see, this can get tricky for military families. Fortunately, those in the military can suspend the five-year test, though the suspension may not exceed ten years, giving you a longer window to satisfy the use test.
If you don’t meet the ownership and use tests, and you sell your home at a gain due to a PCS or other unforeseen circumstance. In that case, you should qualify for a partial gain exclusion, where the exclusion is prorated for the months you did live and own the property.
When you sell a property that has been a rental, you’ll have to account for depreciation recapture. The IRS assumes you depreciate your investment each year over the useful life (27.5 years). Depreciation effectively lowers your tax liability. So it makes sense that if you sell the property at a gain, the IRS will want to recapture what has offset your tax liability in prior years. You can learn more in IRS Publication 523, Selling Your Home. Remember, when in doubt, get a tax professional.
Tax Deadlines And Extensions
In a non-pandemic America, Tax Day is historically April 15 (adjustments for weekends and holidays). In 2021, due to COVID, the tax deadline was extended to May 17, 2021.
By being in the military, though, you have more flexibility than the rest of the population. Suppose you find that you need an extension for any reason, file Form 4868 before tax day. Be aware that interest will incur from the date the payment was due if you owe taxes. However, if granted an extension, you won’t incur failure to file penalties.
If your duty station is outside the U.S. or Puerto Rico, you can get an automatic two-month extension, and after two months, if you still need time, you can request up to another four-months. To get the two-month extension, you need to attach a statement on your tax return explaining that you’re in the military and on duty outside of the United States and Puerto Rico. As stated above, if you owe taxes, the interest will begin on the original due date of your tax return (April 15).
Combat Zone Extension
Extensions to file and pay your taxes are available to service members serving in a combat zone automatically. The deadline to file is 180 days after leaving the combat zone. Though the extension is automatic, you or your spouse need to notify the IRS by calling or emailing [email protected] and providing:
- Stateside address
- Date of birth
- Date of deployment to the combat zone
- Official document indicating area or the operation
- DO NOT INCLUDE SSN!
If you get a Combat Zone Extension, the interest penalties will not accrue from the original due date (April 15).
Payroll Tax Deferral
The Payroll Tax Deferral was an executive order passed in August 2020 and began in September 2020. It’s the deferment or postponement from paying Old Age, Survivors, and Disability Insurance (OASDI), the official Social Security name.
OASDI comprises two parts: FICA- Social Security (6.2%) and FICA- Medicare (1.45%). The payroll tax deferral is deferring the Social Security portion, or 6.2%, from September 2020- December 2020. In January 2021, the deferrals stopped, and repayment began.
You will have all of 2021 to pay back the deferral amount. Instead of the 6.2% Social Security tax resuming, you’ll be paying 12.4%. That is the 6.2% you normally pay plus the repayment for the deferred 6.2%!
Read more about the Military Payroll Tax Deferral or listen to How to Plan your Payroll Tax Deferral Money on the Military Money Show.
Tax Resources for Military
Filing your taxes isn’t something most people look forward to. If you aren’t ready or desire to do your taxes on your own, there are some free resources available to military families.
Volunteer Income Tax Assistance
Volunteer Income Tax Assistance, or VITA, is a service that provides military families with an IRS-certified tax preparer to help them file their basic federal and state tax returns. This service is available to military families who are CONUS & OCONUS.
Volunteer Income Tax Assistance locations
IRS Free File
For those with an Adjusted Gross Income of less than $72,000, the free file software allows you to file your taxes online for free.
TurboTax makes their federal and state filing free for all active duty service members. It’s also free to reservists who are E1-E9, but it’s not free for officers. The TurboTax Military applies to any of their online products: the Free Edition, Deluxe, Premier, and Self-Employed.
H&R Block Military
H&R Block does give a 10% military discount at some of its locations at the Exchange. You can find a list of the sites where the tax preparation discount is available.
Military OneSource Taxes
MilTax through Military OneSource is a do-it-yourself tax software that’s available to service members to prepare and electronically file your federal and state tax returns. The tax software will walk you through doing your return. If you have questions along the way, you can call a MilTax consultant at 800-342-9647 or reach out to your local VITA office. MilTax is available from January through October.
You can also learn more about MilTax and other resources through the Military OneSource app. The app gives you 24/7 access to experts, military guides, and information on benefits.
AARP Foundation Tax-Aide
AARP Foundation Tax-Aide provides virtual and in-person tax services to service members, veterans, and their families. Tax-Aide will help you file both your state and federal state returns for free. You do not need to be an AARP member or over 50 to get tax help. They provide tax services regardless of age and membership.
Here’s The Bottom Line
Taxes are something you have to do. When it comes to your military taxes, you don’t have to be a tax expert but having a basic understanding of tax and the benefits for the military community can save you money and time. If you need help with your taxes, there are a lot of resources for the military community. So reach out and get your taxes ready, filed, and done!
If you want to “kickstart” your finances in the military, you can get access to my free Financial Kickstart Kit here.
Featured image by Airman 1st Class Tyrone Thomas