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Five Tax Tips for Military Families

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photo courtesy of Arvind Balaraman

It’s tax time again, and that means my phone will be ringing with friends who ostensibly want to say “hello” but in reality have a tax question. Sit for the CPA exam and see if you don’t get the same treatment! Being a military family offers some tax advantages, but it also results in some tax questions. Here are five questions from actual military families like yours. Actually, your military family has never feigned interest in me just to get tax tips, and I am grateful.

Which parts of my (my spouse’s) pay are taxable? Generally speaking, anything labeled “pay” or “bonus” is taxable, anything labeled “allowance” is not. IRS Publication 3, Armed Forces’ Tax Guide, has an explicit list of which items fall into which category, so I won’t reproduce it here.

Combat pay isn’t taxable, and service in a combat zone excludes some pays from your income. Again, refer to IRS Pub 3, even if you’ve benefitted from these exclusions before. The rules can change, and it may be different than it was some years ago.

We finally sold our house! It’s a shame we have to pay taxes on the gain. – I am aware, gentle reader, that this is technically not a question. We digress. Home owners can exclude the gain on the sale of a home (up to a certain limit) if they meet the “ownership and use” tests. The good news is military members are excluded from the use test.

The ownership and use tests, in simple words, say to exclude the gain you must have owned the home for at least two years and you must have used the home as your primary residence for more than two years, both within 5 years prior to the date you sold the home. Military members can waive this 5 year period (within limits). Here’s the IRS’ own example:

John bought and moved into a home in 2003. He lived in it as his main home for 2½ years. For the next 6 years, he did not live in it because he was on qualified official extended duty with the Army. He then sold the home at a gain in 2011. To meet the use test, John chooses to suspend the 5-year test period for the 6 years he was on qualified official extended duty. This means he can disregard those 6 years. Therefore, John’s 5-year test period consists of the 5 years before he went on qualified official extended duty. He meets the ownership and use tests because he owned and lived in the home for 2½ years during this test period. (from IRS Publication 523)

The rules on this can seem a bit complicated (there’s an understatement, huh?), and there are some other conditions, so if you were in this situation, look at IRS Publication 523, Selling Your Home, or consult a CPA or tax specialist.

The IRS lets you deduct PCS expenses from your taxes? Sweet! – Yes, gentle reader, tax policy is indeed very sweet. If you PCS’d and your expenses were in excess of what you were paid for the PCS, you can deduct the excess amount from your taxes. Publication 521 provides the details for this. Note that to be able to deduct moving expenses you’ll have to prove your expenses exceeded the amount the government paid you. This is rare, so perhaps it isn’t as sweet as we might have thought.

The IRS lets you deduct Uniform costs, which is great. – Yes, I agree that tax policy is great and again I do realize this wasn’t a question. It is also a common misconception among military members, particularly among young Ensigns and Second Lieutenants who have just paid the budget of a small Central American country for uniforms with no recompense. Here’s the rub: according to Publication 529, uniforms and their upkeep generally aren’t deductible for active duty members unless the uniforms are specifically prohibited from wearing when off duty (i.e. working uniforms or BDUs – consult your Chief or Sergeant if you’re not sure what uniforms you can’t wear off duty. They will tell you.). Class “A” uniforms, mess dress, those awesome jump boots that take the shine and fit like a glove– none of these expenses are deductible. Reservists who aren’t allowed to wear their uniforms in their “real” lives, however, can deduct their uniform expenses.

Other rules for deductions apply, including the pesky “2% of AGI” rule, so consult Pub 529 or a tax pro.

photo by the Internal revenue Service

Why does <insert state here> keep trying to tax my pay?  I’m a resident of <insert other state here>! – The Soldiers and Sailors Civil Relief Act of 2003 precludes service members from having to change their state of residence for tax purposes just because of a PCS. The Military Spouse Residency Relief Act of 2009 extended the same protection to military spouses, and is summarized here. If you are covered by either of these laws (and make sure you are), the state where you currently reside can compel you to file a return, but cannot compel you to pay taxes to them. If you are having this difficulty, consult base legal and the state in question immediately!

Bear in mind that I am not a CPA, and my advice isn’t gospel by any means. If you’ve got questions and aren’t sure what to do, the best place to start looking for answers is the IRS’ own website, www.irs.gov  (I can tell you from personal experience if you call the assistance number you will probably have someone read to you what you’d find on the website).  Failing this, try base legal or a tax professional. Taxes don’t have to be stressful; take advantage of the help that’s available to you and you’ll be fine. And you can reserve your phone calls to friends to actually find out how they’re doing.