Tax credits for military are right on target

If tax laws mirror a nation’s values, America clearly values its military personnel – and more so today than a few years ago.

Combat-zone tax exclusions, combined with changes to the earned income tax credit and child tax credits, have reduced or even wiped out the tax liability of thousands of military families.

For many, taxes have been replaced by extra cash in the form of refundable tax credits.

“That’s exactly what these credits were designed to do for the low-income individual,” said Vincent Mullett, a retired Marine and a senior IRS tax specialist in San Marcos, Calif., near Camp Pendleton. But Mullett said he knows of colonels who now qualify for earned income tax and child tax credits.

Mullett and Raphael Tulino, an IRS spokesman for Southern California and Nevada, reviewed the 2005 tax highlights for service members. Later, Army Lt. Col. Jane Fenton, executive director of the Defense Department’s Armed Forces Tax Council, offered more insights.

The first thing military taxpayers should know, IRS officials said, is that they don’t have to tackle tax returns on their own. Free help is available year round, on military bases stateside and overseas, through the IRS’ Volunteer Income Tax Assistance program.

Staffed by IRS-trained volunteers using the latest tax-filing software, the program is open to active duty, military retirees, reserve component members, service spouses and survivors. Tax returns filed electronically can generate refunds in seven to 10 days. That should encourage even cash-strapped families to avoid the fees of commercial tax services or the exorbitant fees charged for so-called refund anticipation loans.

Military members now serving in combat areas don’t have to worry about getting in their 2005 tax returns on time. IRS tax actions are suspended until they leave combat areas, and then they have six months to file. Even that deadline is extended automatically by the number of days a member served in a combat zone from Jan. 1 to April 15, the normal U.S. tax-filing period.

Even in peacetime, military personnel enjoy some tax breaks, because a portion of military pay is provided as tax-free housing and food allowances, or in kind government housing and meals.

On average, Fenton said, allowances represent about 25 percent of officer compensation and 33 percent of enlisted compensation. The average value of tax breaks on those allowances, she said, is about $5,000 for officers and $2,500 for enlisted.

In a combat zone, all enlisted and warrant officer pays are nontaxable. Only the combat tax exclusion for commissioned officers is capped, for 2005 at $6,529 tax-free a month. A member who serves even a day in a combat zone receives that month’s pay tax-free. Likewise, all bonuses or special pays received are tax-free, which encourages members to re-enlist or extend service obligations while serving in combat areas.

Combat tax breaks become even more valuable when combined with tax credits available to millions of other Americans. Here’s how:

* Earned income tax credit: For 2005, it provides a refundable tax credit of up to $4,400. The maximum is payable to qualified families with taxable earnings of $11,000 to $16,400. Those who earn less or more still can qualify for some cash credit. But for 2005, adjusted gross income must be less than $37,262 (married filing jointly) for families with two or more qualifying children, and less than $33,030 for families with one qualifying child.

In 2003, when U.S. forces invaded Iraq, many low-income military families saw their earned income tax credit fall because combat zone service had left them with little or no taxable income. Ironically, many officers suddenly qualified for the credit because long combat tours had lowered their taxable income sharply.

The Working Families Tax Relief Act of 2004 corrected this inversion. It allowed members to choose whether to include combat-zone income when calculating the earned income tax credit. Higher-income personnel continue to exclude combat-zone pay to qualify for the tax credit; lower-income personnel include their combat-zone pay for the same reason, to qualify for or raise their earned income tax credit.

Defense officials had urged Congress to restore earned income tax credit levels for enlisted personnel serving in combat zones, but to end windfall credits for higher-paid personnel. Congress ignored part two of that request. The 2004 changes to the earned income tax credit law are set to run through tax year 2006.

The Defense Department doesn’t track numbers of service members eligible for the earned income tax credit.

“We just know anecdotally,” Fenton said, “that there are significant numbers of people impacted by that change.”

* Child tax credits: Like many taxpayers, military families also can qualify for the child tax credit, up to $1000 per child under age 17. For a family with two children, that is $2,000 off their tax bill. But what if families have modest incomes and little or no tax liability?

For these families, Congress approved the additional child tax credit. This one can convert the unused portion of the child tax credit into a cash refund. Many military families qualify.

The value of combining combat tax breaks with family tax credits can be substantial, Mullett said. He worked up an example of an enlisted member with a spouse and two children who earned $25,000 in basic pay during a full year in Iraq. The spouse earned $12,000. On their 2005 return, the couple would get back all federal taxes withheld, a total of $8,456, plus $6400 in tax credits ($4400 earned income tax credit and $2000 in additional child tax credit).

If the same member did not serve in a combat zone, the couple would have a combined taxable income of $37,000. Again, they would get back all federal taxes withheld, but only $577 in the additional child tax credit.

In a future column, we’ll review other military-related tax issues.

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