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Life in the military can demand 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
Tax Freedom
If you serve in a combat zone as an enlisted person or as a warrant officer for any part of a month, all of your income received during that time 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. Iraq, Afghanistan and Kosovo all qualify as combat zones.
Savings Potential
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 Individual Retirement Account (IRA). Since your IRA can grow tax deferred until you withdraw the money, the larger contributions today can provide a real savings boost over the years. You can make a 2010 IRA contribution and a spousal IRA contribution until the April 18, 2011, tax filing deadline, plus any applicable extensions.
Exceptions to the Rules
Extra 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 up to 180 days after you've returned from a combat zone, hazardous duty area or certain other deployments.
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 Spouse 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 even get a refund by filing a return in that state.
Filing Remotely
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.
Help With Expenses
Moving Deductions
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.
Separation Assistance
If you're transitioning back to civilian life, you may be able to deduct some costs you incur while looking for a new job. Expenses may include:
- travel
- resume preparation fees
- outplacement agency fees
Moving expenses may be deductible if your move is closely related to the start of work at a new job location and if you meet certain tests.
Breaks For Guard and Reserve
Travel Deductions
If you're called more than 100 miles away from home to perform your reserve duties, you can deduct any unreimbursed travel expenses.
Uniform Deductions
If you are prohibited from wearing certain uniforms when off duty (a rule that usually applies to reservists), you can 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.
Waived Penalties
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 59. You'll still be subject to pay income tax on the distribution, but without the extra sting of the penalty. Get the details.
Free Tax Assistance
On Base
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.
Online
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).
