Taxes are confusing, and when your career involves several relocations, income earned in multiple states (and countries), and a variety of benefits that come from different sources, they can become even more complex. The good news is that serving in the military comes with a number of tax advantages. Once you know about them, preparing your taxes may feel a lot simpler.
1. Know what income is taxable.
While your base pay is generally taxable, some money that you earned while serving in a qualified tax-exempt combat zone is mostly excludable from your taxable income. Both enlisted servicemembers and warrant officers have no limitations on the amount of income that can be excluded; however, income earned by officers is limited to the maximum rate of enlisted pay plus imminent danger or hostile fire pay earned for each month in a combat zone.
Aside from basic pay and imminent danger or hostile fire pay, there are other types of compensation that are eligible for the Combat Zone Tax Exclusion:
- If you reenlisted or extended your service while serving in a combat zone, any bonuses earned are also excludable from your taxable income.
- If you sell any leave that is accrued while in a combat zone, the resulting income is excludable.
- If you are repaying student loans, you can exclude the portion of the repayment that is associated with the period of time you spent in a combat zone.
Note that the Combat Zone Tax Exclusion covers any income that was earned during the same month as your service in a combat zone; even if you were only present in the combat zone for a portion of the month.
The tax-exempt portion of your pay should be reflected on your W-2 and no additional action is needed on your part. Remember, your Basic Allowance for Housing (BAH) and your Basic Allowance for Subsistence (BAS) are never taxable, and they will also be reflected on your W-2.
2. Know where to file taxes.
Regardless of where you currently live or are stationed, active duty servicemembers may need to file income taxes in their home residency state. This may be the location where you lived when you joined the military or another state if you previously changed your legal residence. The location where you currently reside and your home residency state may or may not be the same. Your State of Legal Residency is defined as where you pay income tax and where you intend to return after military service. Your Home of Record is the state where you lived when you first entered into the military and generally does not change.
If you currently live in a state that collects income tax, but your state of residence does not collect income tax, the state where you live cannot enforce the payment of state taxes on your military income. However, if you receive income from other sources (e.g., a rental property), that income will need to be declared and taxes filed in the state in which it was earned.
The Military Spouse Residency Relief Act allows military spouses to use the same legal residence as the servicemember during any taxable year of their marriage regardless of where they reside, provided the spouse’s location resulted from their servicemember’s military orders. The same law also allows a spouse to keep the residency of their home state or to establish residency in the state where they are living.
3. Know that there are extensions available.
If you are serving in a combat zone during tax season, you have 180 days from your return from the combat zone (or from the last day of any continuous qualified hospitalization for an injury that resulted from service in the combat zone) to file your federal taxes. No interest or penalties will be charged during the extension period.
You may also qualify for a two-month extension on your federal taxes if your service is outside of the United States or Puerto Rico, even if you did not serve in a combat zone. However, if you owe any IRS payments, they will begin accruing interest on their original due date.
Note that while federal extensions are available to servicemembers, states may have other policies. Contact a tax expert to learn more about your home residency state’s requirements.
4. Know how to handle DOD and VA benefits.
When a servicemember dies during active duty service, the Department of Defense provides their designated beneficiary with a $100,000 death gratuity to cover immediate expenses before other benefits become available. This money is tax-exempt for the beneficiary.
The HEART Act allows survivors to roll over their death gratuity and insurance payments into tax-advantaged accounts, helping ensure their financial security. However, according to the IRS, death gratuity and SGLI payments may be rolled over into a Roth IRA or CESA only if the contribution is made before the end of the 12-month period after which the beneficiary received those payments.
VA benefits, including disability compensation, pension payments paid to disabled veterans or their families, and GI Bill education benefits, are also tax-exempt and do not need to be reported as income when filing a tax return. Those receiving VA benefits will not receive any tax forms from the IRS.
Note that military retirement pay is fully taxable by the federal government but may be tax-exempt in some states.
Military OneSource offers free tax services to servicemembers and their families through MilTax. You can contact a tax consultant by calling 800-342-9647 or use their tax preparation software to file your taxes. If you have questions about DOD or VA benefits, Navy Mutual’s Education and Veterans Services team can help answer your questions. Our representatives can be reached at 888-298-4442 or education@navymutual.org.