The IRS code includes many special rules written to make life easier for military personnel. Some allow certain types of income and allowances earned by servicemen and women to be excluded from income tax; others make it easier to avoid tax penalties and increase the amount of your refund.
Let’s see how some of those tax exclusions and special rules work:
If you serve in a combat zone for any part of a month, you are entitled to exclusion from the combat zone for the entire month.
That means that, in addition to any active duty, imminent danger, or hostile fire pay earned, all wages from duties at clubs, masses, post theaters, and stations, as well as most other unallocated fund activities are exempt. In addition, all military awards received for suggestions, inventions, or scientific achievements, voluntary reinstatement bonuses, increased leave pay earned, and student loan repayments made during that time are also excluded.
Other military income that is not taxable includes state bond payments, combat zone bonuses for service in a combat zone, as well as certain military allowances. Payments for moving, travel expenses, benefits in kind, plus family and death allowances are not taxable.
Military members are given extra time to make IRA contributions, tax deadlines are extended when they serve or are injured while serving in a combat zone, they don’t pay early withdrawal penalties when drawing an IRA, and they can use combat zone exempt income to qualify for the Earned Income Credit. If you sell your home because you are moving to a new permanent station, all early sale penalties are also waived.
Servicemen and women may qualify to defer payment of income taxes owed immediately before or during their military service until a later date, and tax liability may be canceled when a member dies while on active duty in the service area. combat, dies from injuries in the combat zone or from injuries sustained in a terrorist or military action.
States also have special tax rules for the military; some do not tax military income at all, while others exempt a portion.
No one pays state taxes on their wages in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming, however, some of the other states exempt military pay even though non-military wages are taxed.
Michigan excludes all military pay, Idaho does not tax active duty pay when a resident is out of state for more than 120 days in the tax year, and military pay received by residents of Pennsylvania and New Jersey based in another state is also exempt.
Maryland does not tax the first $15,000 of military pay when a resident is stationed outside the US, Arizona excludes the first $6,000, and Indiana the first $2,000.
Other states with income exclusions on certain types of military income include Florida, Iowa, Montana, North Dakota, New York, New Hampshire, Ohio, Vermont, and the District of Columbia.
That’s the short version of available military exclusions and special rules; Hope that clears up any opt-out confusion. And remember, when the military exclusions and special rules are combined with all the special rules and exclusions written for families, the military can reduce your tax bill by hundreds of dollars, year after year.