How Does Military Tax Free Pay Work?

A common question that both active duty and dependents ask prior to and during a deployment is how does military tax free pay work? Until one deploys, this topic is not widely understood by those on their first enlistment or newly commissioned. The United States government realizes that deployment to a combat zone is exhausting in every aspect (mentally, emotionally, and physically), and provides a number of tax benefits to active-duty and reserve members of the armed forces. The IRS combat zone exclusion guidelines published by the IRS govern what type of pays are eligible to be tax free while deployed along with the cap or maximum amount allowed by the law.

What are the Guidelines for the Combat Zone Tax Exclusion?

Luckily the IRS is pretty clear on what the tax benefits are if you or a loved one is serving in a combat zone or location that is on the approved list for combat zone tax benefits based on direct support to military operations. Typically, the tax free benefit will entitle the member to not Colors2have to pay state or federal taxes up to a set limit each month he or she is serving in a qualifying area of the world. Much to the chagrin of many a young person; however, FICA (aka Social Security) is still paid. The following are the conditions that will qualify a person for eligibility for the tax exclusion if they work in:
1 – An area that while outside of the combat zone or hazardous duty area that DOD certifies is in direct support of military operations in a qualifying hazardous duty area or combat zone, and the member receives imminent danger or hostile fire pay,
2 – A qualified area designated by Congress while receiving imminent danger or hostile fire pay in accordance with US law, or
3 – In a combat zone as designated in an executive order or by the Congress.

What Pay Qualifies for the Combat Zone Tax Exclusion ?

One nice piece of the current law is that although hostile fire and imminent danger pay is day-for-day, service members are still entitled to a full month of tax free pay if they have a part of one qualifying day in a given month. Please note: Active duty pay that qualifies for the tax exclusion may not exceed the senior enlisted member of the member’s service pay for the month plus hostile file and hazardous duty pay for officers. Whether one is an enlisted member, warrant officer, or commissioned officer, the following pays may be excluded from one’s earned income for tax purposes:
– Active duty pay earned in any month you serve in a combat zone
– Imminent danger/hostile fire pay
– Reenlistment bonus pay if the voluntary extension or reenlistment occurs in a month served in a combat zone.
– Awards for suggestions, inventions, or scientific achievements because of a submission you made in a month you served in a combat zone.
– Pay for accumulated leave days earned in any month served in a combat zone.
– Pay received for duties as a member of the Armed Forces in any non-appropriated fund activities.
– Student loan repayments made during deployment to a combat zone
*Note: BAH and BAS remain tax free independent of whether or not one serves in a tax exclusion zone.

What Happens if a Person is MIA or a POW?

If a serving member of the United States armed forces is officially declared MIA or a POW as a direct result of serving in a combat zone, he or she will continue to earn tax free pay for duration of time they are in this status.

How Does Tax Free Pay Work if hospitalized in the War Zone?

If you get injured or get sick while serving in a combat zone, then your tax exclusion will extend during the time you are in the hospital. If the member passes away while in the combat zone, the taxes for the year are either refunded or forgiven by the IRS depending on the person’s individual circumstances.

How Does Tax Free Pay Impact IRA Contributions?

The tax code (and the IRS as a result) really goes out of its way to benefit the service member. Although pay earned while in combat is not counted as earned income when doing your taxes, it does count for your total gross income when IRAs (individual retirement accounts) are taken into account. This is because your gross overall income determines your deduction limits and contributions for IRA accounts.

References

Combat Zones Approved for Tax Benefits
https://www.irs.gov/newsroom/combat-zones

IRS, Tax Exclusion for Combat Service
https://www.irs.gov/individuals/military/tax-exclusion-for-combat-service

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