By Mark Steber, Chief Tax Officer, Jackson Hewitt Tax Service Inc.
Like many other occupations, being a member of the military has certain advantages when it comes to filing an annual tax return. Here are a few to note:
Treating Nontaxable Combat Pay as Earned Income
Combat pay is usually treated as nontaxable income for tax purposes. In some cases, such as with the Child Tax Credit, the Additional Child Tax Credit and the Making Work Pay Credit, active duty taxpayers must include their nontaxable combat pay as earned income when they take advantage of the credits. Although this does not make the combat pay taxable, it often ensures the taxpayer will receive the credit.
In other cases, a military taxpayer can choose whether or not nontaxable combat pay is included in their earned income calculations. Both the Earned Income Tax Credit (EITC) and the Child and Dependent Care Credit allow you to choose whether you should include your nontaxable combat pay in your calculations. Many taxpayers will determine the amount of each credit both with and without the combat pay in order to choose the most optimal situation. If the taxpayer and their spouse are both military, the spouse is allowed to make their election independent of the taxpayer’s election. A similar, two-step process is also used when determining IRA contributions.
Tax Extensions Due to Combat Zone Duty
Military members who are serving in a combat zone have most of their tax requirements suspended for that period and are granted an extension. The extension consists of the total of all days in the combat zone plus 180 days after leaving the zone and any specified time to complete the tax scenario. For example, a taxpayer is in the combat zone beginning April 1 through December 31, 2010, their extension to file their 2009 tax return consists of the entire time they are in the combat zone, plus the 15 days from April 1 through April 15, plus the 180 days allowed. This extension applies to IRA contributions, filing and paying current taxes due, and resolving prior year tax issues. There are no penalties imposed for failing to file or pay taxes and interest is suspended while in the combat zone and under the special extension rules.
Military taxpayers who are overseas on the tax deadline day (traditionally April 15th) can receive an automatic two-month extension to file their tax return. They must still pay 90% of their taxes by April 15th to ensure they have no interest on a balance due.
Usually, you can exclude up to $250,000 ($500,000 if you file as Married Filing Jointly) of the gain on the sale of your main home if you live in the home and have owned the home for two of the last five years prior to the sale of the home.
If you are active duty military and you move from your main home due to a new permanent duty station (PCS orders), you can choose to suspend the five year test period for up to ten years. For example, David, active duty Army, bought and moved into his home in 2001. He lived there for 2½ years; in 2003, he received PCS orders to another state. Although the five year test period ended in 2006, David did not sell his house until 2009. Because David was on orders for the Army and unable to live in the house, he was able to suspend the five year test period for the six years between 2003 and 2009.
Many taxpayers have already taken advantage of the First-Time Homebuyer Credit. Military members that receive orders to relocate after December 31, 2008, and received the credit after 2008, are not required to repay the credit. For example, Marc bought his house on February 2, 2009, receiving an $8,000 credit. The Navy then transferred him to another state in March 2010, but Marc will not have to repay the $8,000 credit.
However, those military taxpayers who received the original First-Time Homebuyer Credit in 2008 are still liable for repayment. Here’s an example: Jenny bought her house in September 2008 and received the full $7,500 credit. Because Jenny received orders to move to another state in March 2010, she is required to repay the $7,500 credit.
In addition, military members that are on orders out of the country for more than 90 days after December 31, 2008 will receive an extension till May 1, 2011 to qualify for the credit. Members of the U.S. Foreign Service and employees of the intelligence community also qualify.
Finally, remember that all qualified mortgage interest and real estate taxes paid are deductible on a tax return. There is no requirement to reduce your deduction by any VHA or BAQ payments received.
For additional questions about credits and deductions, contact your local tax preparer.
Mark Steber is chief tax officer with Jackson Hewitt Tax Service. With over 6,300 franchised and company-owned offices throughout the United States, Jackson Hewitt is an industry leader providing full service individual federal and state income tax return preparation. For more information or to locate a nearby Jackson Hewitt office, visit www.jacksonhewitt.com or call 1-800-234-1040.