By Summer 2021 M-VETS Student Advisor David Zhang
This blog post is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Military members and their families have life events that may affect their tax situation. This blog post discusses some of the tax law issues active and reserve military personnel may encounter. Specifically, the post aims to explain federal tax benefits related to combat pay and sale of home, under IRC §§112 and 121, respectively.
- What Is Income:
Since these tax breaks either allow taxpayers to exclude or deduct certain items from gross income, the blog post first discusses gross income. The Sixteenth Amendment to the United States Constitution gives Congress the power “to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states and without regard to any census or enumeration” (emphasis added). Similarly, Section 61 of the Internal Revenue Code (IRC) provides:
Except as otherwise provided in this subtitle, gross income means all income from whatever source derived… (emphasis added).
This Section then provides a non-exclusive list of gross income items. Apparently, in defining gross income as “all income from whatever source derived,” Congress states its intention to exercise the full measure of the power granted to it by the Sixteenth Amendment. See Glenshaw Glass Co., 348 U.S. 426 (1955).
- What is Not Income:
After briefly discussing what is income, the blog post moves on to a much more interesting topic—what is not income. Despite that Congress has the power to tax “incomes from whatever source derived,” in some situations, Congress excludes what may otherwise be accessions to wealth that are clearly within the scope of IRC § 61. The Internal Revenue Code has a series of sections providing such exclusions. Here, the post provides two examples of exclusions that may be available to active and reserve military members.
- Combat Zone Tax Exclusions:
First, under IRC § 112, a member of the United States Armed Forces who served in a combat zone can exclude income from taxation. IRC § 112(a) provides that gross income does not include “compensation received for active service” as a member below the grade of commissioned officer in the Armed Forces of the United States for any month during any part of which the member “served in a combat zone.” IRC § 112(b) provides that “gross income does not include so much of the compensation as does not exceed the maximum enlisted amount received for active service as commissioned officer in the Armed Forces of the United States” for any part of which the member “served in a combat zone.” For the purposes of this Section, the term “commissioned officer” does not include a commissioned warrant officer. Id.
In addition, IRC § 112(c)(2) provides that the term “combat zone” means any area which the President of the United States by Executive order designates for purposes of this section as an area in which Armed Forces of the United States are or have engaged in combat. Executive Order 12744 designates the following locations (including airspace above) as combat zone:
Arabian Sea (North of 10 degrees North Latitude and West of 68 degrees East Longitude); Bahrain, Gulf of Aden; Gulf of Oman; Persian Gulf; Iraq; Kuwait; Qatar; Oman; Red Sea; Saudi Arabia; and United Arab Emirate.
Executive Order 13119 designates the following locations (including airspace above) as combat zone:
Albania; The Adriatic Sea; The Federal Republic of Yugoslavia (Serbia/Montenegro); and The Ionian Sea north of the 39th parallel.
Further, Executive Order 13239 designates Afghanistan as combat zone. Under the 2017 Tax Cuts and Jobs Act (TCJA), military members who performed services in the Sinai Peninsula can also claim combat zone tax benefits. In addition to these locations, the Department of Defense (DoD) also certified several other countries for combat zone tax benefits due to their direct support of military operations in combat zones.
In short, under IRC § 112, enlisted members and commissioned warrant officers can exclude all military pay for each month present in a combat zone while commissioned officers are limited to the highest rate of enlisted pay for each month present in any of the combat zones mentioned above.
- Capital Gain Exclusion from Sale of Principal Residence:
Second, IRC § 121 excludes the recognized gain on the sale of a taxpayer’s principal residence in an amount not to exceed $250,000 or $500,000 for joint returns. This exclusion—one of the most widely used tax breaks in the Code—is even more favorable to military members and spouses because the Section gives them the ability to take advantage of the exclusion for longer periods of time. In addition, the exclusion is especially important to military families since they often sell their houses in permanent change of station (PCS) moves.
This exclusion is available to a taxpayer once every two years, but the taxpayer must have used the property as a principal residence for a total of two years during the prior five-year period ending on the date of the disposition. IRC § 121(a). For a military member, the running of the five-year period is suspended during any period that the military member is serving on qualified official extended duty. IRC § 121(d)(9)(A). However, the five-year period cannot be extended more than 10 years. IRC § 121(d)(9)(B). For the purposes of this Section, an individual is on qualified official extended duty if for more than 90 days or for an indefinite period, the individual is either (1) at a duty station that is at least 50 miles from his or her main home, (2) or residing under government orders in government housing. IRC § 121(d)(9)(C).
To summarize, if a taxpayer makes a profit in the sale of his or her home, the taxpayer can generally avoid paying capital gains taxes on up to $250,000 of that profit, or $500,000 if married filing jointly, as long as the taxpayer has lived in that home for at least two of the last five years. IRC § 121. If the taxpayer is a military member on “qualified extended duty,” the five-year-period can be suspended (but a suspension period cannot be more than 10 years). IRC § 121(d).