Maximizing the EITC for deployed troops

An election to recognize tax-exempt income so service members can qualify for this valuable credit exists, but should be automatic so it’s not a trap for unsophisticated taxpayers.
By Christopher Pascale

President Ronald Reagan celebrated the Tax Reform Act of 1986, P.L. 99-514, which expanded the earned income tax credit (EITC) and indexed it for inflation, as "the best anti-poverty bill, the best pro-family measure, and the best job-creation program ever to come out of the Congress of the United States" (comments at the signing ceremony as reported in the Los Angeles Times (Oct. 22, 1986)). The EITC is usually considered an acceptable tax benefit by people on both sides of the political aisle because a person cannot receive it without working to earn an income, although some criticize it as the "unearned income credit" because it may result in a refund well beyond what a taxpayer paid in.

Regardless of how one feels about the EITC, many people would be surprised to know that most U.S. service members, when they are deployed in a combat zone, receive a much lower tax refund from the EITC than they do when they are based at home in the United States.

This article discusses why deployed troops who are in harm's way are getting less benefit from the EITC, how it affects their households, and a simple solution to the problem with which reasonable people  can agree.

Why do deployed troops receive lower tax credits?

A benefit to being in a combat zone is that one's income is received tax-free (Sec. 112). This exemption, which applies to enlisted members, warrant officers, commissioned warrant officers, and (with limits) commissioned officers (IRS Publication 3, Armed Forces' Tax Guide), provides some relief for troops and their families as they deal with the added hardships that come with the job, but the upfront benefits of having no taxes taken from one's pay can be washed out by the effects on the back end.

The average U.S. enlisted service member with a family may pay no income tax after deductions simply because the salary is so low. However, when combat pay is excluded from income, the service member may fail to qualify for certain refundable credits that require earned income, such as the additional child tax credit and the EITC.

On the flipside, higher-ranking commissioned officers can earn tens of thousands of dollars tax-free while deployed, and then can receive thousands of extra dollars from the EITC.

Is it the fault of captains, majors, and colonels if they receive this extra cash at tax time? Of course not! But should thousands of frontline troops suffer a lower benefit when they are taking risks that most Americans will not have to even consider?

How does the lack of EITC refunds affect military troops' budgets?

I served in the U.S. Marine Corps from 2003–2008 and deployed to Fallujah, Iraq, for eight months in 2005. As a result, only four months of my income was taxable. Six months after returning home, I received a significantly lower tax refund.

Today, a lance corporal (E-3 military pay grade) in the same situation—who was deployed for eight months in 2016—will have a taxable income of $8,328 instead of $24,984 (his or her entire year's salary). If he or she is married with two children, the amount of the EITC will be $3,330 instead of $5,312, costing the family about $2,000 they had anticipated receiving. If that lance corporal's tour of duty is extended due to the needs of the military, then his or her taxable income will be even lower, making the service member's (and his or her family's) sacrifice even greater as they might receive no refund at tax time.

And while deployed service members can qualify for these credits if they have a spouse who is working, for many families this is not an option. For example, children under 6 weeks old do not qualify for day care on most military installations, and the average cost of day care in Jacksonville, N.C. (home of Camp Lejeune) per the website is $10.25 an hour. Many military spouses would earn less than this from temporary employment in a city they are typically passing through as a result of being a member of a military family.

The current solution to the problem of reduced EITC refunds for members of the military with combat pay is to allow them to make an election to count that untaxed combat pay when calculating the EITC. This Sec. 32(c)(2)(B)(vi) nontaxable combat pay election can increase the service member's EITC, but not all tax preparers know about it, meaning that many of those who could receive a higher credit don't.

The election is all or nothing—if made, all nontaxable combat pay must be included when making the EITC calculation. Depending on the service member's situation, this may not result in a bigger EITC. There is evidence that few military personnel take advantage of this election, and those that do often do not make the optimal choice when deciding on it (see Gleason and Tong, "Nontaxable Combat Pay Election and the Earned Income Credit.")

One solution

A solution would be to allow troops to receive the maximum EITC amount for their family size when they are deployed to a combat zone for 90 or more days during a tax year. For single filers with no children, the maximum EITC for 2016 is $506. For a married couple filing a joint return with three or more children, the maximum EITC is $6,269.

This should be an automatic claim for any and all service members from E-1 (the lowest pay grade, which applies to enlisted members when they enter the military) to O-10 (the highest pay grade for officers). There should be no requirements for this treatment beyond combat zone deployment.

The automatic claim would end the current approach's requirement of additional knowledge of what is to many an obscure rule that tax preparers must elect.

This change would simplify the tax code, albeit slightly, but, more importantly, it would serve to enhance the welfare of our individual troops.

Christopher Pascale is an accountant currently serving as a paralegal for the IRS's Office of the Chief Counsel on Long Island, N.Y. He has an MBA in Accounting from St. Joseph's College, which he attained with help from the Post-9/11 GI Bill.

These views are the author's and do not necessarily reflect those of the U.S. Department of the Treasury or the Internal Revenue Service.

Opinions expressed in the Tax Insider are those of the individual writers and may differ from policies of the American Institute of Certified Public Accountants, the Tax Division, or its other divisions and committees.

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