Senior service members use tax breaks

by Tom Philpott

Congress has passed legislation to end a quirky reduction in tax breaks that hits lower-income military families when their service members are assigned to Iraq, Afghanistan or other combat areas.

Relief from the tax break glitch was part of the Working Families Tax Relief Act of 2004 approved Sept. 23 and sent to the White House. It applies only to tax years 2004 and 2005 but it could be extended.

Last year up to 10,000 service members saw combat-zone tax exemptions lower their family income, for some by thousands of dollars. The combat-zone exemptions did so by lowering reportable income enough that families lost eligibility for the more valuable Earned Income Tax Credit.

Victims of this tax break “inversion,” as a defense official called it, typically are lower-grade enlisted members or junior officers who are married with children, serve at least seven months in a combat zone, and have little or no other family income.

What they lose is the EITC, a refundable credit for low-income workers approved it in 1975 to offset the burden of Social Security taxes and to provide an incentive to work. Income thresholds to qualify for EITC vary by family size. For example, if workers have one qualifying child, taxable income must fall below $30,338 (or $31,338 filing jointly).

But they also must have some taxable income.
EITC eligibility can mean refundable tax credits, which put extra cash in pockets. The maximum credit in 2003 was $4,204 for a worker with two or more children, $2,547 with one child and $382 for a childless taxpayer.

It’s a more valuable tax benefit than combat tax exclusion for lower income families who pay little or no taxes any way. In combat areas, enlisted and warrant officer income is tax exempt. Officer earnings are too, but only the first $6315.90 each month in 2004.

Sens. Mark Pryor, D-Ark., and Max Baucus, the ranking Democrat on the Senate Finance Committee, co-sponsored the original bill to protect EITC eligibility. Now part of the new tax law, it will allow members, if they choose, to have combat zone income count toward EITC eligibility.

Choice, here, is important because not all members lose valuable tax breaks. Some senior enlisted members and even senior officers gain income from the way combat-zone exemptions and the EITC interact. Tax break windfalls occur if they serve only part of a year in a combat zone, leaving just enough taxable income to qualify for EITC.

Earlier this year, Defense Department officials drafted, but never sent to Congress, a proposal to end both the tax break penalty for lower-income service families and the EITC windfall for higher-income combatants. This election year Congress chose only to end the unintended negative effect.

Baucus said Sen. Blanche Lincoln, D-Ark., offered an amendment during a closed-door conference committee on the tax bill to make the military tax break relief provision permanent. It was defeated by the Republican majority on a straight party-line vote, Baucus said.

Tom Philpott can be contacted at Military Update, P.O. Box 231111, Centreville, Va. 20120-1111, or by e-mail at:
milupdate@aol.com