Military service members and veterans face unique challenges when filing taxes, with special provisions and benefits that can significantly affect their tax situation. Here are five of the most helpful things that military families should understand to maximize their benefits.
Use Military OneSource
Military OneSource provides exclusive tax benefits through their MilTax program. The service is available to active duty, National Guard, Reserves and veterans (within 365 days of separation). It includes comprehensive online tax preparation software, multistate filing capability (up to three states), and access to military-specific tax consultants. This service is better than the standard “free” filing services offered by commercial providers.
Know the state tax residency rules for military and spouses
Military members have the unique ability to maintain one state as their legal residence despite frequent relocations. They can choose between their home of record or another state where they’ve established residency, which can result in significant tax savings, especially in states with no income tax. Each state’s laws are detailed at the My Army Benefits website.
Under the Military Spouses Residency Relief Act (MSRRA), military spouses can share the service member’s state of residency even if they live in a different state due to military orders.
This could allow you to avoid state income tax in certain states, depending on where you claim residency. When filing jointly, veterans should determine whether their spouse’s income is taxable based on these residency rules.
Veterans should note that once they leave service, their residency is typically based on their physical location, unless they maintain legal ties to a previous state. It’s crucial to research state-specific treatment of military retirement pay, as policies vary significantly between states.
Leverage capital gains tax exclusion when selling a home
With home price appreciation, fortunately, most people make money when they eventually sell their homes. The IRS permits everyone to exclude up to $500,000 of gain if you have lived in the home. Frequently, military members buy a home, get orders to move, and then rent that home to others. Fortunately, as explained in IRS Publication 523, there are special provisions that may allow you to still exclude capital gains.
Normally, to qualify for this exclusion, you must have lived in the home for at least two of the last five years. However, veterans on qualified official extended duty can extend this five-year window for up to 10 years. So you could have lived in your home for two years up to 15 years ago, rented it for the past 13 years (while on extended orders), and then can still exclude up to $500,000 in capital gains when you sell it. If you’ve been renting out your home, you should be aware that depreciation deductions taken while renting could be taxable upon sale.
Use the combat zone tax exclusion
While on active duty, if you served in a combat zone, you can benefit from a Combat Zone Tax Exclusion. This exclusion allows certain military pay earned while in a combat zone to be excluded from federal income tax. In most cases, the Defense Finance and Accounting Service will calculate that based on your entry to and exit from combat zones and report that to you on your monthly leave and earning statement. Double-check to ensure that those dates correctly reflect the dates that you entered and departed the combat zones.
In addition to reducing your normal taxable income, if you received bonuses, reenlistment pay, or certain incentive pay while in a combat zone, these amounts may also be excluded from taxation. If you contributed to the Thrift Savings Plan while in a combat zone, not only is that income excluded from taxes, but you can make that contribution to a Roth TSP so that your contribution and the earnings can be withdrawn tax-free (as part of a qualified distribution).
Veterans should pay close attention to the conversion of TSP contributions made in a combat zone. When you convert those contributions into another qualifying retirement plan, like an IRA, ensure that combat zone contributions are converted to a Roth IRA to maximize the tax-saving benefits.
Deduct reserve travel expenses
If you are serving in the Reserves or National Guard, you may qualify for tax deductions related to travel and training expenses by using Form 2106. This includes travel expenses beyond a 100-mile threshold, lodging and meal costs, uniform expenses (for items not suitable for civilian wear), and professional development costs. Importantly, these deductions remain available without itemizing deductions on tax returns.
Maximizing your tax benefits as a veteran
Understanding military tax benefits requires attention to detail and awareness of special provisions. While complex, these tax advantages can provide significant financial benefits when properly utilized. Stay informed about changes in tax law affecting military members, and don’t hesitate to seek professional guidance for complex situations. Key resources include MilitaryOneSource.mil, IRS Publication 3 (Armed Forces Tax Guide), Installation Legal Assistance Offices, and military-specific tax professionals.
Michael Meese is president of the American Armed Forces Mutual Aid Association.
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