Content Manager posted on January 01, 2006 10:14
January 2006 - Navy
by LT Marc J. Soss, SC, USN
Most Naval Reservists have two full-time employers (civilian job and the Navy Reserve). Your civilian job allows you to provide for your family while your military service allowes you the opportunity to serve and protect the United States. Both of those affiliations are a trade or business and qualify your expenses as tax deductible.
This article is meant to assist you in filing your 2005 Federal Income Tax Return (Form 1040); make you aware of available tax credits and deductions; and lower, to the extent legal, your tax burden. It is important to understand that nonreimbursed expenses you incur, while performing duties as a Naval Reservist, are tax deductible.
Preparation of Your 2005 Federal Income Tax Return
Unless an extension is filed, your 2005 Federal Income Tax Return must be filed with the Internal Revenue Service on or before 15 April 2006. The following portion of this article will assist you in preparation of your 2005 Form 1040 Federal Income Tax Return.
Lines 1-5: Filing Status: Notifies the IRS as to the type of taxpayer(s) that is filing the return: single; married filing jointly; married filing separate return; head of a household; or qualifying widow with dependent child.
Line 6: Exemptions: Lists the number of individuals (single, married couple, and dependents) claimed on the return and information (Social Security number(s) and relationship to you) about them. You may be able to deduct $3,200 on line 42 for each exemption listed on the return. An additional exemption may be available if you provided housing to someone displaced by Hurricane Katrina.
Lines 7-22: Income: Your 2005 income and benefits consist of the following:
Civilian income: Salary or wages; tips; taxable and tax-exempt interest; capital gains and losses; foreign earned income (exclusion amount applicable); bonus; back pay; dividend income; alimony received; deferred compensation; dependent care benefits provided by your employer; education expenses reimbursed by your employer; busi- ness expense reimbursements; pensions and annuities; rental real estate income; royalties; business income (S-Corporation, Partnership, or sole proprietorship); trust income; employer contributions to medical savings accounts; employer-provided vehicles; Social Security benefits; excess salary deferrals; moving expense reimbursements; severance pay; sick pay; and unemployment benefits received.
Military income: Basic pay (active duty, back wages, drills, reserve training); special pay (aviation career incentives, career sea, diving duty, foreign duty [outside the 48 contiguous states and the District of Columbia], foreign language prof iciency, hardship duty, hostile f ire or imminent danger, medical and dental off icers, nuclear-qualif ied officers, special-duty assignment pay); bonuses (career status, enlistment, overseas extension, reenlistment); and incentive pay (submarine, flight, hazardous duty, high altitude/low altitude [HALO]).
Foreign Source Income: Income (earned and unearned) from sources outside the United States must be reported unless exempt by U.S. law. Certain taxpayers can exclude income earned in foreign countries. However, the exclusion does not apply to the wages and salaries of military and civilian employees of the U.S. Government.
Important Note: Individuals mobilized or who performed Active Duty for Special Work (ADSW) will receive two W-2 statements for the tax year. The W-2’s are a function of the two pay systems operated by the Defense Finance and Accounting Service (DFAS) that provide military pay: (1) all active duty personnel (mobilized, Presidential Recall, and ADSW [periods greater than 30 days]); and (2) all inactive duty personnel (drill pay, Annual Training, Active Duty for Training, and Funeral Honors Duty).
Military Exclusion from Income: Living (Basic Allowance for Housing, Basic Allowance for Subsistence, housing and cost-of-living allowances abroad); moving allowances (dislocation, base realignment and closure benefit paid after 11 November 2003, moving household and personal items, storage, temporary lodging, and associated expenses); travel allowances; combat zone pay (limited for officers); family allowances (education expenses for dependents; emergencies, evacuation to a place of safety); death allowances (burial services, death gratuity payments to eligible survivors, travel of dependents to burial site, counseling); ROTC education and subsistence allowances; survivor and retirement protection plan premiums; uniform allowances; in-kind military benefits (dependent-care assistance program, legal assistance, medical/dental care, commissary/exchange discounts, space-available travel on government aircraft).
Methods to Reduce Taxable Income:
Retirement Account(s): A member of the Naval Reserve is permitted to participate in a retirement account (employer sponsored or on an individual basis). This decision is premised upon the fact that Reservists (not serving more than 90 days of Active Duty) are not considered covered by U.S. government retirement plans. In 1993, the State of California challenged this premise and mailed assessments to Reservists disallowing their IRA deductions for prior years. Their logic was that the Reservist was covered by the U.S. Government retirement plan. When IRC 219(g) (6)(A) and (B); Notice 87-16 was quoted to California, the assessment was removed. If your State disallows your retirement plan deduction due to your drilling as a Naval Reservist, quote the above IRC references and contact the Naval Reserve Association.
a. Employer Established Retirement Plans: The 401(k) elective deferral limit is $14,000. If you will be 50 years old by 31 December 2005, you may contribute an additional $4,000 (catch-up contribution).
b. Individual Retirement Accounts: IRA Contributions, to be deductible, are subject to various limitations (filing status and “Modified Adjusted Gross Income”). If your spouse is covered by a Pension or Profit Sharing Plan, you will be able to deduct your IRA contributions subject to a phase-out, if your joint modified AGI is $150,000 to $160,000. All others can contribute to an IRA on a nondeductible basis. In addition, deductible IRA contributions up to $4,000 (plus a $500 makeup allowance for those over the age of 50) may be made for each spouse (including a nonincome producing spouse) as long as the combined compensation of both spouses at least equals the contributed amount.
c. Thrift Savings Plan: Members of the Reserve are eligible to make deductible contributions to a Thrift Savings Plan (TSP). You have 60 days from the date you enter the Reserves to make your initial election. The amount you can contribute is based upon the applicable annual IRC contribution limit and changes annually. In 2005, the IRS elective deferral limit is $14,000. If you are over age 50, you may also make an additional catch-up contribution of $4,000. Those that contribute to the TSP from their basic pay may also contribute from their incentive or special pay (including bonus pay).
Lines 23-37: Adjusted Gross Income: This section consists of deductions (standard or itemized) to the income and benefits calculated under lines 7-22 above.
Standard Deduction:
The standard deduction amounts are the following: $5,000 for single or married filing separately; $10,000 for married filing jointly or qualified widow; and $7,300 for a head of household.
Miscellaneous Itemized Deductions:
These deductions phase out at $145,950 for single and joint tax filers and at $72, 975 for separate returns filed by a married individual. Itemized deductions will also be reduced by three percent of the amount by which the taxpayer’s adjusted gross income (AGI) exceeds the income threshold, up to a maximum of 80 percent of allowable deductions. The following is a list of the available deductions and their respective limits, if any:
Itemized Deductions (Not subject to two percent limitation):
These deductions consist of: Educator expense ($250 deduction if certain qualifications are met); business expenses (Reservists, performing artists, and certain government officials); $2,500 student loan interest deduction (subject to an AGI phase out at $135,000 for married filing jointly and $65,000 for all others); health savings account deduction; moving expenses; one-half of self-employment tax; real estate taxes; self-employed health insurance deduction; Keogh Retirement Plan; Self-Employed SEP and SIMPLE contribution deduction; alimony payments; penalty on early withdrawal of savings; and mortgage interest paid (subject to limitations).
State and Local Sales Tax: State and local sales taxes are deductible (actual purchase amount) or pursuant to an IRS created table (not created as of the date this article went to print). Those electing the deduction must choose between deducting their sales taxes or their state and local income taxes. If the IRS table is used, the sales tax paid on automobiles, boats, and other items specified by the IRS are also deductible. Residents of Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming will receive the biggest tax benefit since these states have no state income tax.
Tuition and Fees: This deduction is available to students for whom no education credit is claimed (maximum deduction of $4,000 if AGI does not exceed $65,000 [$130,000 on a joint return] or $2,000 if AGI is between $65,000 and $80,000 [$130,000 and $160,000 on a joint return]).
Charitable Contributions: Contributions to a church, temple, united charities, etc., are eligible for the deduction. Also, contributions made to your ship, post, Reserve Center, or station, provided that the funds are used SOLELY for recreation, amusement, or welfare (MWR) of service personnel, are deductible. Charities are now required to inform you of the deduction limits for quid pro quo contributions when you make a payment of more than $75.00. Gifts in excess of $250 require a written acknowledgment from the receiving organization.
Contributions to the Naval Reserve Association: Contributions of money or property to the Naval Reserve Association qualify as a charitable contribution. If you make a gift of appreciated property to the NRA, you can receive a tax deduction for the property’s full market value without having to pay tax on its appreciation in value.
Capital Loss Carryover: Up to $3,000 ($1,500 if married filing separately) of capital losses, in excess of capital gains, can be deducted as an offset against other income. Capital losses may also be carried forward to offset a capital gain the next year.
Exceptions:
The business expense deduction provides eligible members of the military an above-the-line deduction for their transportation, meals, and lodging expenses (not reimbursed) incurred when traveling more than one hundred (100) miles away from home and staying overnight to attend meetings. The deduction amount will be calculated at the maximum travel rate expense allowed for federal government employees. This deduction benefits all applicable Reservists regardless of whether they itemize on their income tax returns. To receive the deduction, you must complete Form 2106, Employee Business Expenses, or Form 2106-EZ, Unreimbursed Employee Business Expenses. Then, include the amount from Form 2106 or Form 2106-EZ on line 24 of Form 1040. Write “RC” and the amount of expense in the space to the left of line 24 on Form 1040.
If you had more than one employer and wages in excess of $90,000 in 2005, with each withholding Social Security tax on your wages, it is likely that too much Social Security (FICA) may have been withheld. You may claim the excess FICA amount as a credit (the “Withholding Tax Credit”) against any income tax that is owed on your Form 1040. It is important to recognize that Social Security tax is withheld from Naval Reservists performing Reserve drills, IDTT, ADT, ADSW, AT, or when on an extended period of special duty.
Itemized Deductions (Subject to 7.5% limitation):
Medical expenses must total at least 7.5 percent of adjusted gross income (AGI) to be deductible. Deductible expenses include the following: doctor, dentist, and chiropractor fees; lab fees; contact lenses and eye glasses; and medical supplies. Health insurance premiums may be included to reach the deductible limitation unless paid by an employer.
Itemized Deductions (Subject to 2% limitation):
1. Military Oriented Deductions:
Unreimbursed Travel Expense to Drills: A Naval Reservist performing inactive duty by attending drill under competent orders, either in a pay or nonpay status, is entitled to deduct the cost of the travel between the city or general area which constitutes your principal or regular place of employment and the drill site (Reserve Center, base, or post) located outside such general area (if you stay overnight or the location is in excess of 50 miles from your tax home). If you are unemployed or a student, you are not entitled to any mileage deductions as an Employee Business Expense. The premise is that you were not traveling between two employer business locations.
For example: A Naval Reservist living and working in Sarasota, FL, and performing drills at MacDill AFB, Tampa, FL, is entitled to deduct the mileage in driving to and from the drill site. You may deduct the cost of flying (commercially or in a private plane) to and from Sarasota plus any incidental costs, i.e., rental car in Tampa,
parking at the Tampa airport, staying at the MacDill AFB CBQ (if available), out-of-pocket meals (subject to 50 percent limitation), mileage to and from the Tampa airport, etc., all related to performing the drill weekend.
You may deduct your round-trip transportation expenses, provided free transportation between such locations is not furnished to you. The deduction is applicable, regardless of whether the Reservist attends drills in the evening after his/her regular working hours or on an otherwise nonworking day. If you are required to remain away from your principal place of employment overnight in performance of authorized drills (IDTs) and training duty (AT/ADT), you may deduct all of the cost of the travel expenses including meals (subject to 50 percent limitation) and lodging (if not furnished), whether you are compensated for such drills and training duty or not.
Administrative Travel: There are many occasions when the Commanding Officer or other Unit members under his or her command are required to drive to the Reserve Center to sign correspondence, make MOBEX telephone calls, give active duty examinations, install/ maintain equipment, and so on. These trips are normally at dates and times other than normal drills. The Reservist involved is entitled to deduct round trip mileage for such trips since the travel was performed in order to meet higher authority directives and during the normal workday. It is recommended that you maintain a log of these additional trips and miles.
Commuting Expense to Temporary Drill Sites: The Naval Reserve Center to which you are assigned is considered your “normal location” for performing drills. If you drive from your residence to a location other than the NRC to attend drills, this will not be a deductible commuting expense for those drills since the first trip of the day is commuting.
Example: If you normally drill at NRC Tampa, FL; live within a 50-mile radius of the NRC; and you do not stay overnight but return home from drill, all of your mileage to and from is considered commuting and nondeductible. However, if you are ordered to report directly to NRC St. Petersburg, FL, or any other “temporary drill site,” except NRC Tampa, your round-trip commuting mileage is deductible only if you report to NRC Tampa first and then you go to the temporary drill site.
It is important to keep any documentation furnished that directs you to go to the other drill location. This documentation includes a Plan of Day/Month (POD/POM), written no-cost IDTT orders, letters from superiors, or any other document that directs your actions. In order to be deductible, you will need to keep track of the mileage from your home to the NRC and then to the temporary drill site.
You may not deduct any part of your transportation expenses incurred in attending drills that are conducted within the city or general locality that constitutes your principal or regular place of employment, unless you are also working at some other business location that same day or you go to a “temporary” drill site. When you attend prescribed drills within the city’s general locality that constitutes your principal or regular place of employment, and on that same day, you were working at some other business location, you may deduct your one-way transportation costs in getting from one such business location to the Reserve Center. Keep records as to the business location, the number of miles driven, and the date of such action.
Transportation Expense Calculation: The deductible mileage rate is 40.5 cents per mile for all miles driven for business from 1 January 2005 through 31 August 2005. The rate increases to 48.5 cents per mile for all miles driven for business from 1 September 2005 through 31 December 2005.
Actual Expenses vs. Standard Mileage Rate Deductions
In order to deduct the actual travel expenses using your vehicle for Naval Reserve meetings:
a. You may not use Accelerated Cost Recovery System (ACRS or MACRS or Section 179) depreciation on any vehicle and use the mileage rate on that same vehicle during the life of the vehicle.
b. You must supply the following information: (i) the date the vehicle was placed in service; (ii) total mileage that the vehicle was used in 2005; (iii) miles used for business (including Naval Reserve); (iv) percentage of business use; (v) average daily round-trip commuting distance; (vi) miles that vehicle was used for commuting; and (vii) other personal mileage.
c. In addition, you must answer the following questions: (i) whether another vehicle was available for personal use; (ii) whether the employer provided the vehicle; (iii) whether personal use was permitted during off-hours; (iv) whether evidence exists to support the deductions; and, if so, (v) whether such evidence is written.
All of this information is required whether you use the mileage or actual expense method. Your daily records can be used by you to determine which method, actual expenses or mileage, would result in a greater deduction.
NOTE: You are not able to claim the standard mileage rate if you use the IRC Section 179 deduction. Annual Reserve/business use will affect the deduction amount. Consult with a tax practitioner before claiming the deduction.
Summary of Reserve Mileage Deductions:
If your normal work week is Monday through Friday, and you attend a meeting of an Armed Forces Reserve unit that meets one weekend a month in the general area of your regular place of work, and you return to your home on Saturday night, the cost of transportation from your home to the Reserve meetings is a commuting expense; and you cannot deduct it unless you go from the NRC to a “temporary drill site” rather than to the NRC.
If the meetings are held outside the general area, you can deduct the cost of your transportation to attend the meetings. The Navy’s definition of “Outside General Area” is living fifty (50) miles or more from the Naval Reserve Center. If the Reserve meetings are held after work on a normal workday, the cost of transportation from your workplace to the Reserve Center is deductible.
If you stay away from home overnight, the cost of hotel/motel rooms and the cost of meals not furnished or reimbursed are deductible. Effective for all years commencing 1994 and later, only 50 percent of the qualified meals and entertainment may be deducted. Hotel/motel/ BOQ room cost is still deducted in full.
Lodging Not Furnished by the Naval Reserve: A Reservist who lives outside a fifty-(50) mile radius from the NRC and will be performing at least two (2) drills the following day is entitled to lodging. In the event the Reservist does not perform two drills the following day or does not schedule the drills timely, the lodging expense paid by the Reservist is a deductible expense which should be included on Form 2106. A Reservist on AT/ADT is reimbursed the cost of the room. If the lodging costs more than the amount reimbursed, the excess is deductible on Form 2106.
Out-of-Pocket Meals (Reduced by 50%): Officers are not entitled to reimbursement for their meals so the expense is deductible on Form 2106. In 2005, the deductible cost of meals is reduced by 50 percent. It is important to keep records of each meal purchased. Alternatively, instead of the actual cost of each meal, you may include your expenses for meals while away from your tax home overnight at the maximum rate authorized paid by the federal government for meals and incidental expenses in the locality where the travel was performed. For details, including the maximum rate, reference IRS Publication 1542 Per Diem Rates (For Travel within the Continental United States). You can use the new Standard Meal Allowance Rates.
Uniforms, Uniform Accessories, and Maintenance: Inactive Reservists are allowed to list on Form 2106 all expense pertaining to the unreimbursed uniform expenses incurred whether in a pay billet or in a nonpay billet. These expenses include maintenance, repair, or alteration of uniforms and equipment, especially required by the Navy, which doesn't take the place of civilian clothing. This includes, but is not limited to: gold lace, devices on uniforms, coat and collar devices, shoulder boards, chin straps, cap devices, gold lace on officer’s visors, wings, sword and full dress belt, and for altering braid and devices on uniforms because of change of rank. If local military rules do not allow you to wear fatigue uniforms when you are off duty, you can deduct the amount by which the cost of buying and keeping up these uniforms is more than the uniform allowance you receive [IRS Publication 17, Your Federal Income Tax].
Dues to Professional Societies Related to Reserves: Reservists are allowed to list, as Miscellaneous Deductions on Form 2106, all expenses relating to membership in the various professional societies related to the Reserves. These include but are not limited to: U.S. Naval Institute, U.S. Naval War College Foundation, Naval Reserve Association, Naval Order of the United States, Reserve Officers Association, Association of Naval Aviation, Vietnam Veterans Association, and others.
Subscriptions to Reserve-Related Periodicals and Purchase of Books: The cost of subscribing to Reserve-related periodicals and the purchase of books, which enhance the mobilization potential of the Reservist, are deductible on Form 2106. This includes technical reference material, historical data, and computer programs detailing the strategy and tactics of historical battles and language training materials. Also, any material, written or magnetic media, or equipment, computer hardware or software that improves the mobilization potential of the individual Reservist is a deductible item.
Computer Expenses, If Used More than 50% for Business and Naval Reserve Purposes (Records are Required): The use of a computer and its peripheral equipment more than 50 percent of the time combined for business and Naval Reserve duties will make it deductible. Records are required to substantiate the deduction or depreciation on Form 4562, Depreciation and Amortization.
Attending NRA Semiannual and Chapter Meetings: National Officers, Anchors, delegates, representatives, and committee members attending semiannual or chapter meetings in 2005 are entitled to a deduction for nonreimbursed travel expenses. The expenses include air fare, the cost of meals (limited to 50 percent) using actual expenses or the per diem amount [IRS Publication 1542] and lodging while away from home in connection with the affairs of the NRA and/or at its direction. Parking fees and tolls attributable to such transportation are deductible as separate items.
Expenses Incurred While an Officer of the Association or a member of Any of the Association’s Committees: If you incur any expense, including travel, meals, purchase of supplies, long distance telephone calls, or have a separate telephone line put in only for NRA use, those expenses are deductible as a charitable contribution. If there is any reimbursement from the NRA or the chapter, ONLY the NET expenses are deductible as a cash charitable deduction.
Retired Reservists Participating in Reserves IAW Permissive Orders: Retired Reservists that participate in the Reserve Program IAW permissive orders program do not file Form 2106 but list all expense incurred as a cash charitable deduction on Schedule A. Permissive orders issued IAW BUPERSINST 1001.39 state that (1) the member will not accrue additional retirement points; (2) the member will not perform additional service for pay purposes (annual training); (3) participation is strictly on a voluntary basis; (4) no IDTT or ADT can be performed; and (5) there is no RESFIRST reporting requirement.
Other Deductible Expenses: The following expenses may also be deductible: (1) change of command or change of office, and special award ceremonies expenses (printing, reception, etc.); and (2) legal expenses incurred by a Reservist in the defense of certain allegations. [IRS Publication 529, Miscellaneous Deductions]
2. Additional Civilian Deductions: Office in Home if Used as Your “Principal” Place of Business: A home office expense can be deductible if it is used as your “principal” place of business. In 1993, the U.S. Supreme Court defined the meaning of “principal” as a two part test: (1) exclusive or regular use for your trade or business; and (2) the business part of your home must be one of the following: (a) your principal place of business, (b) a place where you meet with patients, clients, or customers in the normal course of your trade or business, or (c) a separate structure (not attached to your home) you use in connection with your trade or business. Additional tests for an employee's use of a part of his/her home include: (1) your business use must be for the convenience of your employer, and (2) you do not rent any part of your home to your employer and use the rented portion to perform services as an employee.
Based upon the above tests, it may be possible for a member of the Naval Reserve to deduct a part of the operating and depreciation expense on his/her home. You cannot deduct any part of personal expenses that are for family household purposes. Confer with your tax practitioner as to the likelihood of sustaining the deduction upon audit by the Internal Revenue Service.
If a percentage of the expenses is deductible, then include house interest, taxes, utilities, insurance, and depreciation and apply the percentage to the total amount of the house expense. Repairs are deductible ONLY for the home office. Other room repair is not allowed. Forms 8829, 2106, and 4562 must be completed to reflect the operating expense and depreciation on the home office. [IRS Publication 17, Part 5, Chapter 30, Miscellaneous Expenses]
Tax Preparation Costs: The cost to prepare your income tax, including preparation software or books or a professional tax preparer, is deductible.
Job Search Expenses: The costs associated with a job search, regardless of your current employment situation, in your line of work will qualify as a miscellaneous deduction. The deduction includes the cost of printing and mailing your résumé, long distance calls related to the job search, and travel costs to an interview location.
Educational Expenses: Educational expenses are deductible if they (1) are required by your employer or by law or regulations to retain your salary, status, or job; (2) maintain or improve your skills required in your job whether within the Reserves or not. [IRS Publication 3, Employee Business Expenses]
Lines 38-45. Tax.
This section of the tax return calculates the amount of your taxable income by deducting your standard or itemized deductions from your adjusted gross income. In 2005, the standard deduction amounts are the following: $5,000 for single (or married filing separately); $10,000 for married filing jointly (or qualified widow); or $7,300 for head of household. For those born before 2 January 1941, the standard deduction amounts are the following: $6,250 for single; $6,000 for married filing separately; $11,000 for married filing jointly ($12,000 if both spouses are over age 65); or $8,550 for head of household.
Kiddie Tax (Form 8814)
The Kiddie Tax applies to unearned income, in excess of $800, of a child under age 14. The child’s unearned income between $800 and $1,600 will be taxed at the child’s marginal income tax rate. Unearned income over $1,600 will be taxed at the parent’s marginal income tax rate.
Line 46. Alternative Minimum Tax.
The alternative minimum tax is a separately figured tax that eliminates many deductions and credits, thus increasing tax liability for an individual who would otherwise pay less tax. The tentative minimum tax rates on ordinary income are 26 percent (on the first $175,000) and 28 percent (excess amount). The 2005 exemption amounts are the following: $58,000 for married (filing jointly) and surviving spouses; $40,250 for single or head of household filers; and $29,000 for married (filing separately). The exemption amounts are phased out by an amount equal to 25 percent of the amount by which the individual’s AMTI exceeds (1) $150,000 in the case of married individuals filing a joint return and surviving spouses; (2) $112,500 in the case of other unmarried individuals; and (3) $75,000 in the case of married individuals filing separate returns. The amounts are not indexed for inflation.
Lines 47-56. Credits.
1. Foreign Tax Credit (Form 1116).
2. Credit for Child and Dependent Care Expenses (Form 2441).
3. Credit for the Elderly or Disabled (Schedule R).
4. Education Credit (Form 8863).
a. HOPE Credit: A maximum $1,500 credits (100 percent on the first $1,000, plus 50 percent of the next $1,000) for qualified tuition and fees paid on behalf of a student (enrolled on at least a half-time basis). The credit is available for only the first two years of the student’s post-secondary education.
b. Lifetime Learning Credit: A maximum $2,000 credit (20 percent of qualified tuition and fees up to $10,000). A student need only take post-secondary classes to acquire or improve job skills.
c. Both the HOPE and Lifetime Learning credit are phased out at modified AGI levels between $87,000 and $107,000 for joint filers, and between $43,000 and $53,000 for single taxpayers.
5. Child Tax Credit ($1,000 per qualifying child under age 17). Phased out for adjusted gross income levels: (i) $110,000 for joint filers; (ii) $55,000 for married individuals filing separately; and (iii) $75,000 for single filers. Under the phase-out rule the credit amount is reduced at the rate of $50 for each $1,000 (or fraction) by which a taxpayer’s “modified adjusted gross income” exceeds the threshold amount.
6. Adoption Credit (Form 8839). Up to a $10,630 credit for each child (special needs child receives the full $10,630 regardless of the amount of expenses). The credit ratably phases out at income levels between $159,450 and $199,450.
7. Mortgage Interest Credit.
a. Home Loan Mortgage Interest. Deductible up to $1 million in
home acquisition debt.
b. Home Equity Loan Interest: There is a $100,000 ($50,000 if married filing separately) limit on the amount of debt that can be treated as home equity debt. Interest on amounts up to the home equity debt limit are deductible while amounts in excess are treated as personal interest and not deductible.
c. The interest on excess equity loan amounts used for investment, business, or other deductible purposes may be deductible.
8. Saver’s Credit: A nonrefundable tax credit based on qualified retirement savings contributions to an employer plan made by an eligible individual (AGI of $50,000 or less on joint returns, $37,500 or less on head of household returns, and $25,000 or less on single returns). The credit is equal to the applicable percentage (based on filing status and AGI) of qualified retirement savings contributions up to $2,000.
9. Other Credits. Prior Year Minimum Tax; Qualified Electric Vehicle; General Business; etc.
Lines 58-63. Other Taxes.
This section includes taxes on the following: Self-employment; tip income not reported to your employer; IRA or Qualified Retirement Plans (early distribution, excess contribution, minimum required distribution); and household employment.
Lines 64-71. Payments.
This section includes: Federal Income Tax withheld (W-2 and 1099); estimated tax payments (2005 payments and amounts applied from 2004); earned income credit (Form EIC); Excess Social Security; Medicare, and RRTA tax withheld; additional child tax credit; and amounts paid with an extension request.
Lines 72-75. Refund or Amount You Owe. This section you either love or hate because it identifies whether you are due a refund or the amount you owe the government.
The following are additional factors that must be considered when completing your 2005 Form 1040 Federal Income Tax Return.
MILITARY SERVICE IN A COMBAT ZONE AND THE IRS
The following is a short list of tax benefits available to our brave men and women that served in a combat zone in 2005.
Exclusion from Gross Income
An enlisted member or warrant officer (including commissioned warrant officers) who performs service in a combat zone will have his/her military pay excluded (not included as a part of your W-2 income) from his/her gross income for all or any part of the month of his/her service in a combat zone [IRC section 112(a)]. For commissioned officers, the monthly amount that will be excluded from their gross income will be capped at the highest enlisted pay, plus any hostile fire or imminent danger pay received [IRC section 112(b)]. For definition purposes, a combat zone means any area that the President of the United States designates, by executive order, as an area in which U.S. Armed Forces are or have been engaged in combat and includes a qualified hazardous duty area. It is important to understand that any income (salary [full or partial] and bonuses) received from sources other than the military will not be tax exempt.
The combat zone income exemption will apply to the following members: (1) those serving directly inside a combat zone and those who participate in operations within the zone, including the airspace over it; (2) any military pay received by a member that is hospitalized as a result of injuries sustained while serving in a combat zone, subject to a two-year limitation. (The two-year limitation period begins to run on the date of termination of service in the combat zone.); (3) annual leave payments upon discharge from the service to the extent the leave was accrued during any month in any part of which the member served in a combat zone; and (4) a reenlistment bonus received in a month that the member is outside the combat zone if they completed the necessary action for entitlement to the reenlistment bonus in a month during which they served in the combat zone. In order to be eligible for the income tax exclusion, your service branch must certify your entitlement to the military pay exclusion on your Form W-2.
IRS Extensions
The deadline extension provision applies to most tax actions that are required to be performed on or after the beginning date for your combat zone, or the date you began serving in that combat zone, whichever is later. The deadline for performing certain actions, applicable to your federal taxes, will be extended for the period of your service in the combat zone plus 180 days thereafter. During the extension period, assessment and collection deadlines will be extended; and interest and penalties attributable to the extension period will not be charged. The extensions will apply without regard to the source of the income. The deadline extension provisions will also apply for a period of hospitalization inside the United States not in excess of five years.
The IRS deadline extension provisions also apply to individuals serving in the combat zone in support of the U.S. Armed Forces, such as merchant marines serving aboard vessels under the operational control of the Department of Defense, Red Cross personnel, accredited correspondents, and civilian personnel acting under the direction of the U.S. Armed Forces in support of those forces. In addition, members who perform military service in an area outside the combat zone can qualify for the extension provisions if their service is in direct support of military operations in the combat zone, and if they receive special pay for duty subject to hostile fire or imminent danger as certified by the Department of Defense. The deadline extension provisions apply to both spouses whether joint or separate tax returns are filed.
The deadline extension provisions apply only to federal estate and gift tax returns. Federal tax and information returns, such as corporate income tax or employment taxes, are not entitled to the extension provisions. The extension provisions will also suspend compliance actions, such as audits or enforced collections.
Qualified Retirement Contribution
If you qualify for an extension, you may make a timely qualified retirement contribution for the prior tax year to your retirement account on or before the extended deadline for filing your income tax return for that year. Any amount contributed to your IRA that is more than the smaller of (1) your taxable compensation or (2) $4,000 ($4,500 if you are age 50 or over) is an excess contribution and must be withdrawn to avoid a six percent (6%) excise tax.
If your taxable compensation will be less than $4,000, you should withdraw the portion of your contribution that exceeds your taxable compensation. You will not be taxed on the distributed amount if you receive the distribution on or before the deadline for filing your federal income tax return. You must also withdraw the amount of net income attributable to the excess contributions while they were assets of the IRA. Alternatively, if you are married and file a joint return, you may be eligible to make an IRA contribution based on your spouse’s taxable income.
Estimated Tax Payments
The deadline extension provisions apply to estimated tax payments and will prevent penalties and interest from accruing if the tax is paid in full by the extended filing due date. In order to insure this protection, it is recommended that you print “COMBAT ZONE” across the top of the return.
Installment Payment Plans
While serving in a combat zone and for 180 days thereafter, you will not be required to make payments on past due taxes. Also, no additional penalties or interest will be charged during this deadline extension period. In order to receive this benefit, you will need to contact the IRS office where you were making the payments.
Form W-2, Wage and Tax Statement
Military pay attributable to your active service in the combat zone that is excluded from gross income will not be reported on your Form W-2 in the box marked “Wages, tips, other compensation.” However, the military pay will be subject to Social Security and Medicare taxes and will be reported on your Form W-2 in the boxes marked “Social Security wages” and “Medicare wages and tips.”
Earned Income Tax Credit (EITC)
The U.S. Tax Code does not include combat pay, the Basic Allowance for Housing (BAH), and the Basic Allowance for Subsistence (BAS) in the definition of “earned income” for purposes of the EITC. However, these exclusions may leave you with no earned income and the inability to claim the credit.
Hospitalization
The deadline extension provisions will apply to an injury sustained in a combat zone for the period that you are continuously hospitalized as follows: (1) outside of the United States including 180 days thereafter; or (2) not in excess of five years inside the United States. Also, subject to a two-year limitation after the date of termination of the combat zone, military pay received by a hospitalized enlisted member as a result of injuries sustained while serving in a combat zone will be excluded from gross income. Commissioned officers are entitled to the same benefit subject to the maximum enlisted per month amount discussed above.
Dependent Children Tax Returns
You are not required to file individual income tax returns for your dependent children while one or more spouse(s) serves in a combat zone. You may use the military service member's extension deadline to file their federal individual income tax returns. It is recommended that you write “COMBAT ZONE” across the top of their tax returns. However, if they are entitled to a refund, you may want to file their tax returns as soon as possible.
Accrued Annual Leave
Annual leave payments to enlisted members of the U.S. Armed Forces upon discharge from the service are excluded from gross income to the extent the leave was accrued during any month in any part of which the member served in a combat zone. If your wife is a commissioned officer, a portion of the annual leave payment she receives for leave accrued during any month in any part of which she served in a combat zone may be excluded. The leave payment cannot be excluded to the extent it exceeds the maximum enlisted amount for the month of service to which it relates less the amount of military pay already excluded for that month.
Reenlistment Bonus
A reenlistment bonus that is earned as a direct result of the completion of actions necessary for its entitlement in a combat zone will be excluded from gross income. This exclusion will apply even if the bonus is received in a month that you are outside the combat zone.
MILITARY TAX DEFERRAL
The Servicemembers Civil Relief Act provides Reservists called to active duty and enlistees in the armed forces may qualify for a deferral of taxes owed if they can show that their ability to pay taxes was affected by their military service. The deferral applies to taxes that fall due before or during military service, and extends the payment deadline to six months (180 days) after the military service ends. No interest or penalty will accrue during the deferral period. A taxpayer must apply for the deferral and show how the military service affected the taxpayer’s ability to pay. A taxpayer must also have received a notice of tax due, or have an installment agreement with the IRS, before applying for the deferral. It is important to recognize that the deferral does not extend the deadline for filing any tax returns.
COMBAT ZONE TAX FORGIVENESS
Federal income tax will be forgiven for the tax year in which a service member dies while serving in a combat zone or from wounds, disease, or injury sustained in a combat zone. The forgiveness will apply to taxes owed in the current year and for any earlier tax year ending on or after the first day the member served in the combat zone. Any tax liability that has been paid and is to be forgiven will also be refunded. The forgiveness insures that no tax liability will be imposed on the decedent’s beneficiary(s).
Eligibility is based upon the following criteria: (1) death resulting from active service, wounds, disease, or injury sustained in a combat zone; or (2) death occurring while serving outside the combat zone but in direct support of military operations in the zone, and the member qualifying for hostile fire or imminent danger pay. The forgiveness provision also applies to any U.S. employee that dies from wounds or injury incurred in a terrorist or military action (activity primarily directed against the United States or its allies or any military action involving the U.S. Armed Forces resulting from violence or aggression against the United States or its allies).
The following documents must accompany all returns and claims for refund: (1) Form 1310, Statement of Person Claiming Refund Due a Deceased Taxpayer, and (2) Certification from the Department of Defense or Department of State. The certification must include the following: (i) deceased individual’s name; (ii) Social Security number; (iii) date of injury; (iv) date of death; and (v) statement that the individual died in a combat zone or from a terrorist or military action.
HURRICANE KATRINA TAX RELIEF
The Katrina Emergency Tax Relief Act of 2005 benefits individuals displaced from their principal residence (located in a core disaster area or Hurricane Katrina disaster area on 25 August 2005) due to the hurricane.
Use of Retirement Funds: Withdrawals and Recontributions. Allows withdrawals, within one year of the disaster date, up to $100,000 from an eligible retirement account. The ten percent (10%) early distribution penalty tax will be waived and the income tax applicable to the withdrawal can be paid proportionally over a three-year period. Withdrawals recontributed into the retirement account during the three-year period, following the distribution date, will receive rollover treatment.
Recontribution of Withdrawals for Home Purchases. Retirement account withdrawals (between 28 February 2005 and 29 August 2005), for purposes of a home purchase in a Hurricane Katrina disaster area, may be recontributed (between 25 August 2005 and 28 February 2006) and receive rollover treatment. The withdrawal will not be subject to the 10% early distribution penalty tax.
Loans for Relief. Increases the size of retirement plan loans to the lesser of one hundred percent of the account balance or $100,000. Loan payments due between 25 August 2005 and 31 December 2006 may be delayed for one year while interest will accrue on the balance not paid.
Tax Credit and Exemptions:
Exemption for Housing Hurricane Katrina Displaced Individuals. Provides individuals, who allow individuals displaced by Hurricane Katrina to use their personal residence, an additional $500 personal exemption ($2,000 maximum) for each displaced person. The exemption requires a minimum 60-day stay in the home and is available in either 2005 or 2006.
Child Tax Credit and Earned Income Credit. Hurricane victims can use their 2004 income to calculate their child tax credit and earned income credit for their 2005 tax returns. This election can only be made if the victims 2005 earned income is less than 2004 earned income.
Charitable Giving:
Cash Contributions. Waives the individual income deduction limit (50 percent of AGI) for 2005 cash contributions made between 28 August 2005 and 31 December 2005.
Mileage Rate for Charitable Use. Increases the charity-related mileage rate to 34 cents a mile for use of personal vehicle in relief efforts between 25 August 2005 and 31 December 2006.
Tax Provisions:
Casualty Losses. Waives the $100 floor and ten percent (10%) of adjusted gross income (AGI) threshold for personal casualty losses incurred on or after 25 August 2005 in the disaster area. The Hurricane Katrina losses may only be claimed as an itemized deduction.
Extension of Time. Katrina victims are eligible for an extension until 28 February 2006 to file tax returns (income, state, and gift), pay any taxes (income, employment, or excise), file a claim for credit or refund, or make any deposits due. Applicable penalties and interest will be waived.
OTHER HURRICANE RELIEF
The tax relief extends until 28 February 2006 the deadline for impacted taxpayers to file their tax returns, pay taxes, and perform other time-sensitive acts. The tax relief will be automatic in counties designated by the Federal Emergency Management Agency (FEMA) as “individual assistance areas” while individuals in designated “public assistance areas” will be required to identify themselves to the IRS as hurricane victims by writing in red ink at the top of their tax forms or any other documents filed with the IRS.
The tax relief will benefit individuals who live, and a business whose principal place of business is located, in the covered disaster areas. The relief includes an abatement of interest and any applicable late filing, late payment, or failure to deposit penalties. The relief will apply to any tax return (individual income tax returns, corporation and S-corporation income tax returns, partnership tax returns, estate and trust income tax returns, estate and gift tax returns, exempt organization returns, employment tax returns, and certain excise tax returns), tax payment, or tax deposit with an original or extended due date falling on or after 23 September 2005.
All workers assisting in the relief activities will be eligible for the relief whether or not they are affiliated with a recognized government or philanthropic organization. In addition, any individual injured or killed as a result of visiting the covered disaster areas is entitled to the relief.
NOTE: THIS ARTICLE DOES NOT ATTEMPT TO ADDRESS ALL TAX LAW CHANGES MADE THIS YEAR. IT IS IMPORTANT TO CONSULT A TAX SPECIALIST WHEN PREPARING YOUR FEDERAL INCOME TAX RETURN.
This article is dedicated to the men and women serving our country around the world. Without your service and contribution to our freedom, this article would not be possible.
Mr. Soss is a tax, estate planning, probate and guardianship attorney located in Sarasota and Tampa, FL. He can be reached at SMSOSS@AOL.COM.