Military Tax Breaks – Uncle Sam Gives Back

Military Tax Breaks Put More Cash In Your Pocket

On the battlefield and at home, military families already make profound sacrifices to keep our nation safe. But if you’re not paying close attention to current tax regulations, you may be giving up even more for your country – in the form of unnecessary tax payments.Tax planning for the average consumer is confusing enough, and the difficult circumstances faced by many military families can make the days leading up to April 15 that much more stressful. While the IRS does offer special tax benefits to help military personnel save money, the fact remains that many families don’t take full advantage of the various opportunities to which they’re entitled. Out of confusion or hastiness, they often end up paying more to Uncle Sam than they actually owe.

It takes forethought and organization, but there’s still time this year to make sure you’re paying your fair share of taxes, and nothing more. A good place to start is by reviewing the IRS Armed Forces’ Tax Guide (Publication 3), which is available online at www.irs.gov. The publication explains the many tax rules that apply specifically to service members.

Even after you decipher IRS instructions, making decisions about tax strategies can be a daunting task. Following are a few tax tips that might help military families keep their cool this April and plan ahead for next year’s return.

Mind Your MAGI

Perhaps the most important figure you calculate in filing tax returns is your modified adjusted gross income (MAGI). MAGI is the amount that determines whether you qualify for certain tax credits and deductions, and it plays a big role in your overall tax liability.

For active duty military personnel, gross income generally includes only basic pay, incentive pay and some special pay and bonuses. Allowances for housing, moving, travel and a host of other items are not taxable and are therefore excluded from gross income. Depending on the service member’s rank, certain pay received while serving in a combat zone or hazardous duty area is also excluded from gross income and is tax-free.

The government automatically subtracts exempt pay from your taxable income, but understanding how the figures are calculated can give you a more complete picture of your tax situation.

Be a Savvy Saver

The government wants us all to have a happy, healthy and – most importantly – independent retirement. That’s why the IRS gives us tax incentives to save money for our golden years.

Through 2006, families may qualify for the non-refundable Retirement Savings Contribution Credit, designed to help offset the costs of contributing to a retirement plan such as the military’s Thrift Savings Plan (TSP), a 401(k) or IRA. Depending on your MAGI and your filing status, you could receive a tax credit equal to 10, 20, or 50 percent of your first $2,000 in contributions.

Even if you’re not eligible for the tax credit, contributing to a retirement plan is usually a good idea. If you or your spouse has an employer-sponsored plan offering matching contributions, you’d be wise to maximize your tax-deferred contributions to receive your full share of “free money.” Another smart strategy for many military families is to establish a Roth IRA. While contributions to a Roth are made with after-tax dollars, the principal can be withdrawn at any time without penalty, and the earnings are tax-free and penalty-free once you reach age 59 ½ and have had the account for at least five years.

The TSP can be a good tool to augment the Roth IRA or a spouse’s 401(k). Beyond the plan’s limits for contributions from basic pay, participants can contribute up to 100 percent of incentive pay or special pay, including tax-exempt pay earned while serving in a combat zone.

Certain restrictions and limitations apply to every retirement plan, so be sure to review the plan’s documentation thoroughly before changing your contribution strategy.

Chalk One Up for Education

If you, your spouse or a dependent you claim on your tax return is enrolled in college or vocational school, be sure to take advantage of one of several education tax credits or deductions.

The HOPE Scholarship Credit allows taxpayers to receive a credit of 100 percent of the first $1,000, and 50 percent of the next $1,000 they spend on qualified tuition and related expenses for each eligible student’s first two years of enrollment. As an alternative, the Lifetime Learning Credit equals 20 percent of the first $10,000 spent on qualified tuition and related expenses for any member of your household enrolled in an eligible institution. For each tax year, you can elect to take either credit, but not both, for each student.

As with most tax credits, your eligibility to receive the benefit depends on your MAGI for the year. If your MAGI is less than $51,000 ($102,000 for married couples filing jointly), you could be eligible to receive at least a portion of the credits mentioned here.

If you find that you’re not eligible for the HOPE or Lifetime Learning Credit, don’t give up yet. For 2003, you can deduct qualified college tuition and related expenses up to $3,000 for you, your spouse, or an eligible dependent, provided your MAGI is less than $65,000 ($130,000 for married couples filing jointly). You may also be able to deduct up to $2,500 of interest paid on student loans. And, if you have children under age 17 at the end of the tax year, you may be eligible for a Child Tax Credit up to $1,000 per child.

Confused about the difference between a tax credit and deduction? A tax credit is a direct dollar-for-dollar reduction of your tax liability, whereas a deduction reduces your tax liability indirectly by reducing your total amount of taxable income.

Find Relief at Home

President Bush enacted The Military Family Tax Relief Act of 2003 to ease the tax burden on families dealing with some common hardships of military life. Perhaps the most widely enjoyed element of the plan will be one that brings tax savings to military families required to sell their homes and relocate.

When any taxpayer sells a primary residence, current regulations allow up to $250,000 ($500,000 for a married couple filing jointly) of capital gains to be kept tax-free, provided they owned and lived in the house for at least two of the previous five years. But because military families move frequently, many haven’t been able to qualify for this exemption – until now. The new law creates a special exception to the “two-of-five” rule for military personnel called to “qualified official extended duty,” allowing them to suspend the rule for up to 10 years for one property.

The news gets even better, as the law is retroactive for qualifying military families who sold their home after May 6, 1997, though filing limitations may apply. Although an amended return must usually be filed within three years of the original return’s due date, the law gives qualifying taxpayers who sold a home before 2001 until Nov. 10, 2004, to file an amended return claiming the exclusion. The IRS asks you to write “Military Family Tax Relief Act” in red at the top of such returns to speed processing. (Use Form 4506 to obtain an earlier year’s return.)

To find out if you’re eligible to take advantage of the revised law, review the IRS’ complete explanation of the Military Family Tax Relief Act at www.irs.gov.

Get Fit to File

Even after finding the end of the tax return labyrinth, the logistics of actually filing the documents can occasionally present challenges for military personnel.

Filing a tax return in the correct state may seem obvious for some, but it’s often a point of confusion for service members stationed away from their permanent home address. As a general rule of thumb, file your return with the state you claim as your home of record. So if you’re stationed in Maine but California is your home of record, you would generally be subject to California state income taxes.

If your military spouse is deployed on active duty, it’s likely that you already have a durable power of attorney, which you will need to exercise in order to file a tax return on his or her behalf. If your spouse has yet to deploy, contact your JAG officer for assistance in drafting this document at no cost. And while you’re at it, JAG can also help you establish other important estate planning documents such as a basic will, health directive and letter of instruction.

Finally, if completing and filing a tax return before April 15 seems hopeless, check to find out if you qualify for a deadline extension. If you or your spouse is serving in a combat zone or hazardous duty area, the IRS offers several options to let you delay filing returns, paying taxes, making claims for refunds and other actions.

These tax tips and other savings opportunities have the power to put extra money back in your pocket – how you use it is up to you. If you’ll get a refund from the IRS this year, make plans now to put it toward something worthwhile, like paying down debt or shoring up an emergency savings fund.

When in doubt, contact a financial advisor for assistance in determining an appropriate tax strategy for your family. The financial benefits and peace of mind gained from professional tax planning often far outweigh the costs. But whether relying on the pros or going it alone, knowing your options is the key to a lifetime of tax savings.

Tax Act Spells Relief for Military Families

This tax season, military families could find more money in their pockets thanks to the Military Family Tax Relief Act of 2003. The Act amends and clarifies several provisions of the tax code that previously put service members at a disadvantage for tax savings. Changes include:

• Loosening rules for exclusion of capital gains earned from the sale of a primary residence for service members called to active duty away from home
• Excluding from taxable income homeowners assistance payments made after Nov. 11, 2003 to compensate service members for declines in property value
• Doubling the military death benefit from $6,000 to $12,000, and making the entire amount tax-free
• Clarifying that dependent care assistance benefits are not included in gross income
• Expanding opportunities to contingency operations for deadline extensions for members serving in combat zones
• Creating an “above-the-line” deduction for certain non-reimbursed travel expenses of National Guard and Reserve members
• Allowing penalty-free withdrawals from 529 plans or Coverdell Education Savings Accounts to pay for qualified tuition at U.S. Military Academies

For detailed information about the Military Family Tax Relief Act, visit www.irs.gov.

By Mitch Swanda, USAA Financial Planning Services