3 tax breaks military families shouldn't forget

Military service involves a lot of sacrifice, and Americans who serve in the Armed Forces work hard to earn the benefits they receive. One of the ways that the government recognizes the service of its military members is by offering tax breaks that try to reflect the value of what they do every day. In particular, three key laws offer valuable tax relief to those who serve our country.

Soldier superimposed on American flag.

Image source: Getty Images.

1. No income tax on combat pay

Active-duty service members are allowed to exclude the pay they receive for their service from their taxable income on their federal income tax returns if it's tied to active combat. Specifically, what the IRS looks for is service in a presidentially defined combat zone or in a Congressionally established qualified hazardous duty are. Hostile-fire or imminent-danger pay qualifies for the favorable tax-free treatment for combat pay. Any qualifying service during a particular month exempts your income for that full month.

There are also provisions that allow some other service members to get tax-free pay. If the Defense Department determines that a member is serving in direct support of combat-zone military operations and therefore receives imminent-danger or hostile-fire pay, then income is treated as combat pay and therefore isn't taxed. In addition, those who are injured as a result of combat-zone service and taken for treatment to a hospital outside the combat zone still qualify for the exemption.

Eligible enlisted personnel can deduct their entire pay. However, commissioned officers are limited to the highest rate of enlisted pay plus any imminent-danger or hostile-fire pay they receive. Your W-2 form should include any amounts that are eligible for tax-free treatment.

RELATED: Taxpayer rights you should know about:

Top 10 taxpayer rights
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Top 10 taxpayer rights
The Right to a Fair and Just Tax System – You have the right to expect the IRS to consider special circumstances that affect your tax liabilities, your ability to pay, or your ability to provide necessary information. You also have the right to assistance from the Taxpayer Advocate Service.
The Right to Confidentiality – You have the right for your confidential tax information to remain confidential unless you authorize its disclosure. IRS employees who violate these rules will be subject to appropriate disciplinary action.
The Right to Be Informed – You have the right to clear explanations of all the tax laws and the corresponding IRS procedures throughout all IRS publications and correspondence. Taxpayers must be notified regarding any IRS decisions involving their account and the outcome must be fully and clearly explained. (Unfortunately, they cannot make the tax code any simpler in their explanation.)
The Right to Pay No More than the Correct Amount of Tax – You have the right to pay only the amount of tax that you legally owe, including any accrued interest and penalties. The IRS is also obligated to apply your tax payments correctly.
The Right to Privacy – You have the right to expect that all IRS actions regarding your account will comply with the law. Actions must not be more intrusive than necessary, and should respect all rights of due process.
The Right to Challenge the IRS's Position and Be Heard – You have the right to object to an IRS action and provide documentation to support your claim. The IRS is obligated to consider the objections fairly and promptly, and to send a response to the taxpayer if they disagree with the claim.

The Right to Appeal an IRS Decision in an Independent Forum – You have the right to appeal IRS decisions and receive a "fair and impartial" hearing from the Office of Appeals. Many tax penalties are included within this right. The IRS is obligated to send you a written response to notify you of the decision. In addition, you generally have the right to take these cases to court.

The Right to Retain Representation – You have the right to an "authorized representative" of your choice to represent you before the IRS, and to acquire assistance from a Low Income Taxpayer Clinic if you can't afford a qualified representative.
The Right to Quality Service – You have the right to "prompt, courteous, and professional" help in your communications with the IRS. Thanks to budget cuts, this has been a difficult one for the IRS to achieve in recent years. Last year produced 8.8 million "courtesy disconnects," aka hang-ups, from the IRS. They pledge to do better this year.

The Right to Finality – Finally (sorry, we couldn't resist), you have the right to know all deadlines for challenging IRS positions, IRS collections of tax debt, and the window of time for an audit in any particular tax year.


2. A higher Earned Income Tax Credit than you'd ordinarily be able to receive

Tax-free income is usually ideal, but there are also a few negative consequences. Some other tax breaks, such as the Earned Income Tax Credit, look to the amount of income you claim from work in determining how much you can save on your taxes. Ordinarily, if you had no taxable income because of the combat-pay exclusion, then you wouldn't be able to claim the Earned Income Tax Credit.

However, military personnel get the benefit of including that excluded income solely for the purposes of determining the credit amount. In particular, if the military service member is the person in a family that has a paycheck, this provision can unlock potentially thousands of dollars of tax reductions that the family would otherwise miss out on taking.

3. Simpler and more favorable treatment for state income tax purposes

Lastly, it's typical for military personnel to get transferred on a regular basis. That can require living in many different states, some of which have extremely high state income tax rates. Moreover, a mid-year move would ordinarily require filing two different state tax returns for different portions of the year, adding to the complexity of filing returns.

Instead, military members are allowed to declare their state of legal residency, and for state income tax purposes, that becomes their tax home regardless of where they're actually stationed. In addition, many spouses of military service members are also allowed to the same benefits, as long as the spouse has some connection to the military member's state of legal residency.

If the state of legal residency has no or low state income taxes, then the savings from this provision can be extremely large. That's especially true when the non-military spouse has outside employment, because the spouse can claim a refund for any improperly withheld state income tax due to paycheck withholding.

Get the tax breaks you've earned

Money can't make up for all the sacrifices that military members make for their country, but the tax breaks that the federal government gives them can make a positive different for their lives and those of their families. If you serve, be sure you get the full benefit of all the tax savings you're entitled to receive.

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