Military Income
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Introduction
This lesson will help you determine which income items received by current and former members of the
U.S. Armed Forces are reportable on the return, and the status of any medical separation pay or pay related
to service in a combat zone.
Community property laws may impact the income reported by some military members on their returns.
Objectives
At the end of this lesson, using your resource materials, you will be able
to determine:
• Which income items received by members of the U.S. Armed Forces
are reportable on the tax return and
• The status of any medical separation pay or pay related to service in a
combat zone
Military Income
What do I need?
□ Form 13614-C
□ Publication 4012
□ Publication 3
□ Publication 525
□ Publication 555
What are the types of income?
U.S. Armed Forces members receive many dierent types of pay and allowances. Some are includible in
gross income while others are excludable from gross income.
Refer to the Volunteer Resource Guide, Tab D, Income, for detailed lists of these types of military pay and
to determine if they are included in gross income or excluded.
What income is includible?
Includible items are subject to tax and must be reported on the tax return. The items listed in Publication 3,
Armed Forces' Tax Guide, Table 1, and the Volunteer Resource Guide, Tab D, Income, are included in gross
income, unless the pay is for service in a combat zone or in a qualied hazardous duty area. All includible
military income will generally be shown on Form W-2, Box 1, and reported on Form 1040 as wages.
If the amount shown on Form W-2, Box 1, diers from the last Leave and Earnings Statement for the current tax
year, advise the taxpayer to contact the local accounting and nance or payroll oce for an explanation.
What income is excludable?
Excludable income does not have to be reported as income on the tax return. The exclusion applies
whether the item is furnished in kind, or is a reimbursement or an allowance.
For example, the Basic Allowance for Housing (BAH) can be excluded from gross income as a qualied
military benet. Excludable income will not be included in the amount on Form W-2, Box 1.
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If U.S. Armed Forces members were provided a commuter highway vehicle (such as a van) by their employer,
refer them to Publication 525, Taxable and Nontaxable Income, and to a professional tax preparer.
EXERCISES
Answers follow the lesson summary.
Question 1: Enlistment and reenlistment bonuses are excluded from a service member's income.
□ True □ False
Question 2: Which of the following items is excludable from U.S. Armed Forces members’ income?
A. Hazardous duty pay
B. Basic Allowance for Housing (BAH) and Basic Allowance for Subsistence (BAS) income
C. Basic pay
D. Hardship duty pay
Homeowners Assistance Program (HAP)
HAP was created to compensate qualied military and civilian employee homeowners when base closures
negatively impact the real estate market or when they are required to permanently relocate during the home
mortgage crisis. These payments for qualied military base realignments and closures are excluded from
income. For additional information go to Publication 3.
What is military separation with disability severance pay?
Disability severance pay has varying eects on a service member’s income and taxes.
What is severance pay?
U.S. Armed Forces members who have been separated from the military after years of service or for
medical reasons are given severance pay, which is generally taxable as wages. If the member receives
disability severance pay and is later awarded Veteran’s Aairs (VA) disability benets, 100% of the disability
severance benet may be excluded from income. The VA makes the determination that the member
is entitled to medical disability benets, and the determination process can take several months, and
sometimes years.
What is VA disability compensation?
VA disability compensation is a monetary benet paid to veterans who are disabled because of injury
or disease incurred or aggravated during active military service. The veteran's service must have been
terminated through separation or discharge under honorable conditions. Disability compensation varies with
the degree of disability and the number of dependents, and is paid monthly. The benets are not subject to
federal or state income tax. The VA does not issue Form W-2, Form 1099-R, nor any other document for
nontaxed veteran's disability benets.
What happens after a service member receives a letter of determination?
Once the VA sends a letter of determination, all future pension payments from the government are oset
by the disability amount paid directly from the VA. Disability payments received directly from the VA are not
taxable and are not included on Form W-2 or Form 1099-R.
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example
Anita Zapata was an active duty service member who was separated due to a medical condition, and
began receiving her military pension in February of the previous tax year. Here are the payments she
reported on that year's tax return:
Payments Amount
• Service pension $33,000
• Active duty pay $ 5,000
In the current tax year, the VA determined that she was retroactively entitled to a VA disability pension
of $837 each month from the date of her discharge (February of the previous tax year). She can amend
her tax return to exclude $9,207 ($837 x 11 months) of the pension she received.
She must attach a copy of her letter of determination to the amended return. Her current tax year Form
1099-R will not include the nontaxable VA disability retirement payments received during that year.
EXERCISES (continued)
Question 3: Disability payments sent directly from the VA to the discharged service member _____.
A. Are taxable
B. Appear on the taxpayer’s Form W-2 or 1099-R
C. Are not included on the taxpayer’s Form W-2 or 1099-R
D. May begin before the VA issues the letter of determination
Although pension payments made before the letter of determination was issued have already been taxed,
the letter exempts from taxes the same amount of previous pension payments. U.S. Armed Forces
members who have already led a tax return and reported that pension income should le Form 1040-X,
Amended U.S. Individual Income Tax Return, and attach a copy of the letter of determination.
What is a combat zone?
A combat zone is any area the President of the United States designates by Executive Order as an area in
which the U.S. Armed Forces are engaging or have engaged in combat. An area becomes a combat zone
and ceases to be a combat zone on the dates the President designates by Executive Order. Publication 3
lists the specic areas and dates.
A taxpayer serving in a combat zone may qualify for relief from certain IRS compliance actions, such as audits
or enforced collections, until 180 days after the taxpayer has left the zone.
Taxpayers qualifying for such combat zone relief may notify the IRS directly of their status through a special e-mail
address: [email protected]. They should provide name, stateside address, date of birth and date of deployment
to the combat zone. They should not include any Social Security numbers in an e-mail. This notication may be made
by the taxpayer, spouse, or authorized agent or representative. For more information visit irs.gov.
Hazardous duty areas are determined by Congress. Members of the Armed Forces deployed overseas,
away from their permanent duty station, in support of operations in a qualied hazardous duty area, or
performing qualifying service outside the qualied hazardous duty area, are treated as if they are in a
combat zone for federal income tax purposes.
Military Income
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example
Sgt. Bobby Osage was not assigned to a combat zone but he performed duty that qualied for hostile
re pay. He can exclude that income.
What is the combat zone exclusion?
Members of the U.S. Armed Forces who serve in a combat zone may exclude certain pay from their
income. The entitlement to the pay must have fully accrued in a month during which they served in the
combat zone or were hospitalized due to wounds, disease, or injury incurred while serving in the combat
zone. They do not have to receive the pay while in a combat zone, in a hospital, or in the same year they
served in a combat zone.
The following section is to help you understand when pay is considered excludable as combat pay. You will
not be making any decisions about what is excludable. The information on the military member’s Form W-2
indicates the amount of combat pay with a code Q. If military members feel the amount is incorrect, refer
them to the local accounting and nance or payroll oce for clarication. Do not change any amounts on
Form W-2 when entering them in the tax software.
What qualies as service in a combat zone?
Service in a combat zone includes periods that military members are absent from duty because of illness,
wounds, or leave. If, as a result of serving in a combat zone, military members become prisoners of war or
are missing in action, they are considered to be serving in the combat zone as long as they remain in that
status for military pay purposes.
When does service outside a combat zone qualify as service inside a combat zone?
Military service outside a combat zone is considered to be performed in a combat zone if the service:
• Is in direct support of military operations in the combat zone, and
• Qualies a member for hostile re/imminent danger pay due to dangers or risks from the combat zone
Military pay received for this service will qualify for the combat zone exclusion if the other requirements are
met.
What is nonqualifying presence in a combat zone?
The following military service does not qualify as service in a combat zone:
• Presence in a combat zone while on leave from a duty station located outside the combat zone
• Passage over or through a combat zone during a trip between two points that are outside a combat
zone, and
• Presence in a combat zone solely for a member’s personal convenience
U.S. service members are considered to be serving in a combat zone if they are either assigned on ocial
temporary duty to a combat zone or they qualify for hostile re/imminent danger pay while in a combat zone.
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EXERCISES (continued)
Question 4: Which of the following may qualify as service in a combat zone?
A. Temporary duty in a combat zone
B. Traveling through a combat zone between two points outside of the combat zone
C. Presence in a combat zone while on leave from a duty station located outside the combat zone
D. Direct support of a qualied hazardous duty area but not entitled to hostile re/imminent danger pay
What is the amount of the combat zone exclusion?
• Enlisted members, warrant ocers, or commissioned warrant ocers who serve in a combat zone
during any part of a month (even one day) can exclude all of that month’s military pay, including awards
and re-enlistment bonuses for which the member becomes eligible while in the combat zone. Military
pay earned while hospitalized due to wounds, disease, or injury incurred in the combat zone can also
be excluded.
• Commissioned ocers (including limited duty ocers) may exclude pay according to the rules for
enlisted members. However, the amount of the exclusion is limited to the highest rate of enlisted pay
plus the amount of imminent danger/hostile re pay received for each month during any part of which
they served in a combat zone or were hospitalized as a result of their combat zone service.
Combat pay is not included in Box 1 wages on the service member’s Form W-2, but the amount is shown in
Box 12, with code Q. If service members believe the taxable wages on Form W-2 are incorrect, they should
contact the local accounting and nance or payroll oce to request a corrected Form W-2.
Nontaxable combat pay may increase the Child Tax Credit or Earned Income Tax Credit. Enter all elds
from Form W-2 when preparing the tax return. The software will determine what is most benecial to the
taxpayer.
Taxpayer Interview and Tax Law Application
Here’s how a volunteer might help taxpayers with combat pay:
SAMPLE INTERVIEW
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. .
VOLUNTEER SAYS… MRS. FANNIN RESPONDS…
Let’s talk for a minute about where your husband was stationed. My husband was in a combat
zone for part of the year. Do
I need to tell you the dates or
anything?
The combat pay is not taxable, but it’s shown on your husband’s
W-2, here in Box 12, with code Q. I will enter that into the
system with the rest of the W-2 information, because combat
pay can increase some tax credits. I can show on the tax return
that he was in the combat zone, but I don’t need to know the
exact dates. Is he serving in Iraq?
That’s right.
Military Income
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TAX LAW APPLICATION
To gain a better understanding of the tax law, complete the practice return(s) for your course of study
using the Practice Lab on L<.
What are the laws regarding community property?
The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas,
Washington, and Wisconsin. Special rules apply to married taxpayers who le separately or who were
divorced during the tax year and their domicile is in a community property state. For military members
residing in these states, the key word is domicile, which describes someone’s legal, permanent residence.
It is not always where the person presently lives.
Married taxpayers who choose to le separately, when subject to community property rules, have to gure
community income and separate income for state and federal income tax.
How do community property laws aect Armed Forces pay?
State community property laws apply to active military pay. Generally, the pay is either separate or
community income based on the marital status and domicile of the couple while the service member was/is
in active military service.
Whether an item is subject to community property laws depends on whether the payment is classied as
active pay or retired/retainer pay:
• State community property laws apply to active military pay. Generally, the character of the pay as sepa-
rate from community income is determined by the marital status and/or domicile of the service member
and spouse while the member is on active military service.
• Armed Forces retired or retainer payments may be subject to community property laws. For more infor-
mation see Publication 555, Community Property.
Summary
Special rules may govern whether certain income received by members of the U.S. Armed Forces is
includible or excludable from taxable income reported on the return:
• Homeowners Assistance Program (HAP)
• Medical separation with disability severance pay
• Combat zone exclusion
• Community property laws
What situations are out of scope for the VITA/TCE programs?
The following are out of scope for this lesson. While this list may not be all inclusive, it is provided for your
awareness only.
• U.S. Armed Forces members who were provided a commuter highway vehicle (such as a van) by their
employer
Military Income
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EXERCISE ANSWERS
Answer 1: False. The payments and withholdings for the enlistment and reenlistment bonuses are
reected on the service member’s Form W-2.
Answer 2: B. The Basic Allowance for Housing (BAH) and Basic Allowance for Subsistence (BAS) are
both nontaxable income.
Answer 3: C. Once the VA sends the letter of determination, all pension payments are oset by the
disability amount paid directly from the VA, which is not taxable and not included on any Form W-2.
Answer 4: A. Military members are considered to be serving in a combat zone if they are either
assigned on ocial duty to a combat zone or they qualify for hostile re/imminent danger pay while
serving in direct support of a combat zone.
Military Income
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Notes
