This week's column is dedicated to the men and women serving in our Armed Forces. Last year two major pieces of legislation were passed that can either reduce — or at least give you more time to pay — your taxes.
I don't have the room here to go into all the details of the "Military Family Tax Relief Act of 2003" or the "Servicemembers Civil Relief Act of 2003." Instead, I'll highlight some of the biggest changes. Be sure to check with your JAG office for specifics on how the various provisions of this act might impact you.
Military Death Benefits
First, if you have lost a loved one in the line of duty my heart goes out to you and your family. Your loss can never be replaced and no amount of money is going to make you feel any better.
As you may know, the Military Family Tax Relief Act (search) doubled the death benefit from $6,000 to $12,000. It also made another important change: it exempted the entire death benefit from income tax. Previously, only a portion of the amount had been tax-exempt. CCH, a national provider of tax information, explains that this is the way it used to be until there was a "glitch" in legislation passed back in 1993. As a result, for the past ten years, only a part of the death benefit has been tax-free. This Act finally corrects this.
And, more importantly, both the amount of the death benefit and the tax-exemption of the full amount are retroactive to Sept. 11, 2001. If you lost a family member in the Armed Forces while he/she was on active duty and the old law was in effect at the time, you should have received a check for the additional death benefit of $6,000.
And, since this correcting legislation just passed last fall, there are a number of military families who received a death benefit in 2001 or 2002 — before this payment was declared tax-free— and who paid income tax on half of it, or $3,000. Maj.Thomas Farmer, an attorney with the Air Force's Legal Services Agency, says to get your tax back all you have to do is file an amended return. Moreover, he says this applies to your state tax return, as well.
How it works: You need to file Form 1040X for the year in which you received the death benefit and reduce the amount of your Adjusted Gross Income by $3,000. (You can download this Form at the IRS website: http://www.irs.gov.) The Internal Revenue Service recommends you write "Military Family Tax Relief Act" across the top of the form in red to speed up your refund. You'll need to contact the Department of Revenue or equivalent agency at the state level to get the necessary form to file for a state refund.
Combat Pay Exemption and Automatic Extension
Pay received by military personnel in a combat zone is also exempt from federal tax. But you still need to file a tax return, especially if your spouse is employed. The good news is if you— or a spouse- is deployed in a combat zone or hazardous duty area, you get an automatic extension on filing your 2003 tax return and paying any tax due.
The April 15 deadline is automatically extended to 180 days after your last day in a combat zone or, if you are wounded, after you get out of the hospital. Plus, you can also tack on additional days if your combat zone duty overlapped with this year's tax-filing season— which runs from Jan. 1- April 15. That's potentially an additional 106 days (don't forget February had 29 days this year!).
In other words, if you were sent to a combat zone or hazardous duty area in October and are still there as of April 15, you have 286 (180 + 106) days after you leave this area to file and pay your 2003 taxes. According to Capt. Tiffany Wagner, an attorney in the office the Judge Advocate General at Wright-Patterson Air Force Base, "You will not have to pay any penalties or interest, even if you owe money" to the government.
How it works: According to Capt. Wagner, "You don't have to do anything" to get this extension. At least as far as the federal government is concerned.
State tax agencies aren't necessarily as lenient. Maj. Farmer says while "many states follow the federal guidelines," it's best to play it safe and check to see whether you are entitled to an extension on filing your state income tax return. Some states are actually more generous than the federal government.
Then there are states like Virginia which, according to Maj. Farmer, is "not giving automatic extensions for 2003 if you are on active duty in Iraq or Afghanistan."
(By the way, anyone working outside the U.S. and Puerto Rico— military or civilian— can get a two month extension on filing their federal income tax return. This type of extension doesn't depend upon whether or not you're in a combat zone. However, an extension to file does not mean you get an extension to pay. "If you do owe money," says Cpt. Wagner, "they'll charge you interest. It's best to estimate the amount you owe and send that in.")
Back Taxes Owed
What about past-due taxes owed from previous years?
Under the Servicemembers Civil Relief Act enlisted personnel as well as reservists and National Guard members who are called to active duty can request that any repayment of back taxes be deferred until 180 days after they leave a combat zone or hazardous duty area. This deadline is further extended by the number of days you had left to respond to the IRS before entering the combat zone. Provided you pay the full amount due by the extension date, there is no interest or penalty.
Unlike the extension on filing and paying your 2003 federal taxes, this privilege is not automatic. You have to notify the IRS or state tax agency. Moreover, you "must be able to demonstrate that your ability to make payments has been 'materially affected' by your military service," says Maj. Farmer. "If you can't demonstrate this, you don't get the tax deferment." If you are successful, all of those "friendly" reminders about making payments will stop.
Say you own a small business and had to leave it in the hands of your lazy brother, Louie, while you served your country in Iraq. You could document how profits have dropped like a rock ever since you were deployed overseas. Or maybe you were a corporate attorney earning a salary of $200,000/year in civilian life and have seen your annual income decline to $50,000 since you were called up to active duty. That would certainly affect your ability to keep up with your tax payments.
How it works: To (temporarily) call off the tax collector, Maj. Farmer says you have to write a letter to the IRS and the state tax agency involved. You can include copies of your prior year's W-2 Form or tax return to show what your income used to be and provide documentation of what your current salary is. The JAG office attached to your unit can help you draft the letter.
You can also let the IRS know of your active duty status by going to http://firstname.lastname@example.org. You simply enter in basic information such as your name, date of birth and date of deployment to a combat zone and email this to the IRS. It matches up your information with the database at the Department of Defense to verify your active duty status and the delinquency notices stop.
Maj. Farmer warns that the database is not as up-to-date for reservists as it is for enlisted personnel. So if you're on active duty in the reserves or Guard, your best bet is to send an actual letter via regular mail.
And, in light of the fact that tax collectors aren't known to be an especially patient group, he recommends going a step further. Just in case your letter get lost in the bureaucracy, "get the name of the person you talked to. The longer the problem goes unaddressed, the more significant it gets." Translation: The longer they have to wait for you to pay up, the more annoyed they get. You don't want to tick off tax collectors.
Tax Break for Reservists and Guard Members
Members of the reserves and National Guard are getting a bigger tax break on unreimbursed travel expenses. In previous years, these had to be listed on your federal tax return under "miscellaneous deductions." The problem was, you had to itemize in order to take advantage of this and even if you did, you got no deduction until your expenses exceeded 2% of your adjusted gross income. Now, you'll get a deduction for the full amount.
How it works: Expenses incurred for travel more than 100 miles from home and requiring an overnight stay should be filed using Form 2106, "Employee Business Expenses," or Form 2106-EZ, "Unreimbursed Employee Business Expenses."
Just don't use this as an excuse to stay at the Ritz. The amount you can deduct cannot exceed the federal "per diem" rate.
Military Academies and 529s
Parents with a child accepted at one of the U.S. military academies now get a break on 529 withdrawals. Generally, there's a 10% penalty if the money from these college savings accounts is not used for higher education expenses. However, an exception is made if the student receives a scholarship. In that case, you can withdraw an amount equal to the scholarship without incurring a penalty (you'll still owe tax on any gains).
Since the federal government is footing the bill when a student attends a military academy, this is essentially equivalent to a scholarship. The Military Family Relief Act finally recognizes this.
How it works: Every freshman at a military academy receives a letter that assigns a value to his/her education— room, board, education. The owner of the 529 account can withdraw an amount equal to the annual cost of the military education and not be subject to a 10% penalty.
Additional changes you should know about
The Military Family Relief Act of 2003 ushered in other changes such as:
— Military families that received dependant care payments, such as for child-care expenses, no longer have to pay income tax on these amounts. This change affects payments received in 2003 or later.
— A payment received from the military to offset a decline in housing values due to a base closing is now considered a "fringe benefit." As such, it is also tax-free, provided it was made after November 11, 2003.
— Military families with a member called to active duty away from home get a break when it comes to the sale of their home. Normally, an individual can exclude up to $250,000 worth of profit ($500,000 per couple) on the sale of a home provided it was their personal residence in 2 out of the previous 5 years. Meeting this requirement can be problematic for someone deployed away from their base. Under this Act, if military orders have kept you from using the house as your principal residence, you can ignore up to 10 years of service away from home.
— Finally, according to the Air Force's Capt. Wagner, one of the most significant tax changes for 2003 involves something called the "Kansas Rules." These affected families where the non-military spouse worked in a civilian job. Essentially, the state where the couple was based would add the income earned by the military spouse to that earned by his/her civilian spouse, even though the military spouse had declared another state as his/her residence and paid tax to that state.
For instance, take the case of a couple based in Ohio. The husband was in the Army, and earned $40,000/year and the wife worked as a teacher in the local school district earning $30,000/year. The husband declared Indiana as his state of residence, so that's the state to which he sent his state income tax. The non-military spouse must pay income tax to the state where she is living.
But instead of Ohio taxing her solely on her $30,000 income, they would tax her based on the couple's total income of $70,000, throwing her into a higher tax bracket and resulting in a higher tax bill. The Servicemembers Civil Relief Act of 2003 has eliminated this practice.
If you or a family member is in the military, be sure you have a copy of IRS Publication 3, the Armed Forces Tax Guide. You can download this from the IRS website or order by phone.
P.S. Certain civilians who are working in a combat zone in support of our troops may also qualify for an extension on paying their taxes. CCH's John Roth says the key is that your job must be in direct support of our troops. For instance, if you are doing training on a certain type of equipment or you are a U.S. government employee you are eligible for the same 180-day extension on both filing and paying your federal income tax.
However, regardless when you eventually pay your taxes, there's a good chance your entire salary is taxable. Individuals who work outside the united states sometimes assume that a portion of their income is automatically exempt from income tax simply because they are working in a foreign country. But you can't make this assumption. Roth says the key is who is writing your paycheck. If you're employed by a U.S. company and working in, say Iraq, then your entire salary is taxable. On the other hand, if you work for a foreign company, then you could have up to $80,000/year is excluded from U.S. income tax.
Ah, you're probably thinking, "But what if I work for, say, the German subsidiary of a U.S. company?" Look at your paycheck. If it comes form the German subsidiary, then you get the $80,000 exclusion. If it is issued by the American parent company, you're S.O.L.— Simply Outta Luck. (But you knew that's what I meant, didn't you?)
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