Posted on: Monday, May 24, 2004

MILITARY UPDATE
Tax break hurting some soldiers

By Tom Philpott

An estimated 5,000 to 10,000 military members fighting in Iraq and Afghanistan last year received combat-zone tax exclusions that had a surprising effect: they lowered family incomes.

Some families saw a net loss in tax benefits of more than $4,000 because wartime tax exclusions disqualified them for more valuable tax breaks including the Earned Income Tax Credit. Even more military families could see the same sort of tax benefit loss in 2004, say congressional auditors.

A Defense Department proposal to address the problem this spring failed to clear the White House's Office of Management and Budget.

Treasury officials said the proposal would lower tax revenues and therefore opposed it.

"We will continue to work (the issue) and try again next year," said Charles S. Abell, principal deputy undersecretary of defense for personnel and readiness.

The notion that combat-zone tax exclusions can lower overall tax breaks for low-income military families sounds counterintuitive, Abell said. So when the first complaints from service members began to surface in January, he was skeptical. Visits with deployed forces, however, confirmed a growing problem, and staff analysis confirmed it.

Victims of the net loss in tax benefits typically are lower-grade enlisted or junior officers who serve seven months or more in combat zones during the tax year, are married with children and have little or no other family income, either from spouses or investments.

Even some members whose spouses work see net losses in tax benefits, according to a General Accounting Office report.

Combat-zone tax exclusions remain a welcome benefit to most service members. Income earned in war zones, including basic pay, bonuses and special pay, are fully tax exempt for enlisted personnel. For officers, the exclusions are capped, with the first $5,958 in monthly earnings excluded in 2003.

But in a report to the Senate Finance Committee this month, the GAO confirmed "unintended consequences" when combat-zone tax exclusions cross with other tax breaks like the Earned Income Tax Credit.

EITC lowers tax liabilities for 21 million working Americans. It not only can wipe out tax bills but can put money in their pockets. Combat-zone tax exclusions affect eligibility for EITC by lowering service members' taxable income. Because low-income military families don't pay income taxes anyway, the combat tax exclusion can eliminate tax credits that otherwise would put cash in their pockets.

The unintended consequences of combat-zone tax exclusions also can be positive. Service members who usually earn too much to qualify for EITC see their tax exclusions lower taxable income to a point at which they can draw refundable tax credits.

"This thing works in a perverse way," said Abell.

When combat tax exclusions are combined with EITC, senior enlisted personnel and, in some cases, even full colonels can qualify for tax credits.

To end this "inversion," said Abell, defense officials drafted the aforementioned legislative proposal that was rejected by the OMB this spring.

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