February 1, 2023

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Help for Military Personnel Confused About Special Tax Rules and Exclusions

The IRS code includes lots of special rules written to make life easier for military personnel. Some allow certain types of income and allowances earned by servicemen and women to be excluded from income tax; others make it easier to avoid tax penalties and increase the size of your refund.

Let’s take a look at how some of those tax exclusions and special rules work:

If you serve in a combat zone for any part of a month, you are entitled to the combat zone exclusion for that entire month.

That means that in addition to all active duty, imminent danger or hostile fire pay earned, all wages from duties in clubs, messes, post and station theaters, as well as most other non-appropriated fund activities are exempt. Plus, all military awards received for suggestions, inventions, or scientific achievements, voluntary re-enlistment bonuses, accrued leave pay earned, and student loan repayments made during that time are excluded as well.

Other military income that is not taxed includes state bonus payments, combat zone bonuses for service in a combat zone, as well as a certain military allowances. Those paid for moving, travel expenses, in-kind benefits, plus family and death allowances are not taxed.

Military members are given extra time to make IRA contributions, tax deadlines are extended when they serve or are injured while serving in a combat zone, they don’t pay early withdrawal penalties when they cash in an IRA, and can use exempt combat zone income to qualify for Earned Income Credit. If they sell their home because they are being moved to a new permanent station all early sales penalties are canceled as well.

Servicemen and women can qualify to defer the payment of income taxes due immediately before or during their military service until a later date, and, tax liability can be canceled when a member dies while on active combat zone service, dies from combat zone injuries, or from injuries sustained in a terrorist or military action.

States too have special tax rules for the military; some don’t tax military income at all while others exempt a portion.

Nobody pays state tax on their wages in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington or Wyoming, however some of the other states exempt military pay even though non-military wages are taxed.

Michigan excludes all military pay, Idaho does not tax active duty pay when a resident is based outside the state for more than 120 days in the tax year, and military pay received by Pennsylvania and New Jersey residents based in another state is exempt as well.

Maryland doesn’t tax the first $15,000 of military pay when a resident is stationed outside the U.S., Arizona excludes the first $6,000, and Indiana the first $2,000.

Other states with income exclusions on certain types of military income include Florida, Iowa, Montana, North Dakota, New York, New Hampshire, Ohio, Vermont, and the District of Columbia.

That’s the short version of military exclusions and special rules available; I hope that clears up any exclusion confusion. And remember, when military exclusions and special rules are combined with all of the special rules and exclusions written for families, military members can lower their tax bill by hundreds of dollars, year after year.