Combat Pay and Related Benefits for Military Personnel

By:
Daniel G. Mazzola, CFA, CPA
Published Date:
Sep 1, 2015

“In war, there are no unwounded soldiers. --Jose Navosky”

As a gesture of gratitude to the members of our armed forces engaged in combat overseas, the U.S. federal government has granted these dutiful men and women an exemption from federal income tax on their regular compensation, instituted bonus pay packages, and established special savings programs.  These benefits, while richly deserved, bring forth certain issues that these individuals-many of them young and inexperienced in personal finance-may not fully appreciate.  It is, therefore, incumbent on those in the financial services community, particularly those who counsel members of our armed forces, to educate themselves on these matters in order to better assist these individuals who sacrifice so much for our country and its citizenry.

Military wages are generally subject to federal income taxes, whether the service member is stationed in the United States or abroad.  For every major conflict since the tax code was permanently legislated in 1913, the federal government has recognized the extreme risks of warfare with special pay or tax benefits for combat service. For example, the Combat Zone Exemption was created to exempt the income of all service members from the tax increases that helped finance World War I, while the Revenue Act of 1950 conditioned benefits on a soldier’s presence in a combat zone, as designated by the president. Today, military personnel serving in combat zones are exempt from federal income taxes not only on regular pay, but also on enlistment bonuses and any special combat wages to which they are entitled.  This compensation is still subject to Social Security and Medicare payroll taxes, however, and may be subject to state income taxes, depending on the state of domicile.  The exclusion is unlimited for enlisted personnel and warrant officers, but constrained to the maximum enlisted wage amount, plus bonus pay, for officers.  The exemption is computed in months, so that anyone serving at least one day is exempt for the entire month.      

Hostile Fire Pay (HFP) and Imminent Danger Pay (IDP) are special monthly pay packages that remit soldiers for physical danger.  HFP is determined by an event (e.g., taking enemy fire) while IDP is determined by a threat (e.g., serving in an area subject to the risk of physical harm).  Members of the armed forces receive $7.50 for each day they serve in an IDP up to a maximum monthly rate of $225, while those exposed to enemy fire are eligible to receive pro-rated HFP of $225 per month.  A service member cannot collect IDP and HFP in the same month.

All military personnel serving in a specified combat zone or contingency operation on April 15 are granted an automatic 180-day extension to file their tax returns and pay applicable liabilities.  The extension does not begin until after soldiers have left the combat zone, and is also conferred if they are hospitalized on April 15 as a result of injuries suffered while on duty in a combat zone.  For those personnel confined to a hospital, the additional extension starts upon their release.

Soldiers serving in a combat zone are permitted to deposit up to $10,000 per year in a special savings account that pays a guaranteed 10% annual rate of interest. To be eligible, the soldier must be deployed in a combat zone for at least 30 consecutive days or one day in three consecutive months.  Interest accrued is taxable, and funds cannot be withdrawn except in situations of hardship or emergency.  The savings accounts must be closed upon redeployment out of the combat zone.

Members of the armed forces serving in a combat zone can contribute to a traditional IRA as well as a Roth IRA based on their combat pay, even though it is not taxed for federal income purposes.  Without this allowance, military personnel who did not have earnings apart from combat zone wages could not make IRA contributions, which must be based on taxable compensation.  Soldiers with combat pay who contribute to a Roth IRA can realize significant advantages: Their deposits are made with money that has not been reduced by federal income taxes.  Their earnings in the form of interest, dividends, and capital gains will not be decreased by taxes while maintained in the account.   At retirement, the amount accumulated can then be parlayed into a source of tax-free withdrawals.

The Earned Income Tax Credit (EIC) was promulgated to offset the burden of payroll taxes and provide an incentive to work.  The amount of credit is low at first, but increases with income earned until it is disallowed after a threshold is reached.  For 2015, the minimum income required to claim the credit ranges from $6580 for a taxpayer with no dependents (applicable credit is $503) to $13,870 for a taxpayer with three or more dependents (credit is $6044).  Because combat pay is not reported as wage income on a recipient’s W-2, it is quite possible that soldiers or their tax preparers would ignore it for purposes of the EIC.  As a benefit bestowed on them for their service, military personnel are permitted to decide whether or not to include combat pay when calculating the EIC.  Service members deployed in combat zones for an entire year would owe nothing in federal income taxes for that period, assuming no other gainful employment.  They could, however, classify this compensation as earned income, availing themselves of the opportunity to collect a tax refund even if there is no liability, as the EIC is a refundable credit.   To qualify for the EIC, a taxpayer must be between the ages of 25 and 65, have less than $3200 in investment income, and not file as “married–separately”.

The Combat Zone Exclusion was established to ensure that those brave men and women fighting our wars were not bearing the burden of paying for them as well.  Although the policy on remunerating risk has changed substantially, and some claim the executive office’s administrative policies and changes to the tax code have eroded its traditional purpose, the tax exemption of combat pay and related benefits has remained true to the original intent of legislators: to recognize the military personnel who bear the risk of conflict.   


Daniel G. Mazzola, CDaniel G. Mazzola, CPA, CFAPA, CFA, is an investment advisory representative with American Portfolios Advisors Inc. He is a Chartered Financial Analyst, Certified Public Accountant and Certified Financial Planner. Mr. Mazzola is a member of the NYSSCPA Personal Financial Planning Committee. His website is http://www.danmazzola.com.  

 
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