January 2011 Navy
By LCDR Marc J. Soss, SC, USN
This article is meant to assist members of the active duty and reserve community (including those serving on active duty) in filing your 2010 Federal Income Tax Return (Form 1040), make you aware of available tax credits and deductions, and lower your tax burden.
Preparation of Your 2010 Federal Income Tax Return:
Unless you are eligible for an extension, your 2010 Federal Income Tax Return must be filed with the Internal Revenue Service on or before 15 April 2011. The following is meant to assist you in preparation of your 2010 Form 1040 Federal Income Tax Return. Lines 1-5: Filing Status: 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: 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 deduct $3,650 on line 42 for each exemption listed in this section. The exemption is not phased out as a result of the 2001 Tax Act (thank you, President Bush).
You may be able to claim a relative on your tax return as a dependent. You must provide over half the relative’s support. The supported individual does not have to live in your household if he or she is your child; a descendant of your child (such as a grandkid); a brother, stepbrother, half-brother, sister, stepsister, half-sister, or a descendent of one of these individuals. The supported individual’s 2010 gross income may not exceed $3,650 to claim them. Gross income will not include the first $2,400 of 2010 unemployment benefits, and it does not include tax-free Social Security benefits.
Lines 7-22: Income: Your 2010 income and benefits:
Civilian Income: Salary or wages; tips; taxable 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; business expense reimbursements; pensions and annuities; rental real estate income; royalties; business income; trust income; employer contributions to medical savings accounts; employer-provided vehicles; Social Security benefits; excess salary deferrals; moving expense reimbursements; severance pay; and unemployment benefits received (the first $2,400 is excluded from income).
Military Income: Drill and active duty pay; special pay (career incentives, language proficiency, foreign duty, hardship duty, hostile fire or imminent danger); bonuses (career status, enlistment, overseas extension, re-enlistment, referral fee); incentive pay (submarine, flight, hazardous duty, etc.); and retirement compensation.
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 up to $91,500 of income earned in foreign countries. Di fferential Wage Payments: Voluntary payments made by an employer to an employee while he/she is serving on active military duty for more than thirty days. The wages are subject to income tax withholding, but not FICA or FUTA taxes, and must be reported by the employer on the employee’s Form W-2.
Unemployment Compensation: The first $2,400 of unemployment compensation received in 2010 will not count as taxable income. Benefits received above that amount are taxable income.
Required Minimum Distributions: In 2010, taxpayers are again required to take a “Required Minimum Distribution” from a traditional IRA or qualified retirement plan.
Conversions to Roth IRAs: Beginning in 2010, the modified AGI and filing status requirements for converting a traditional IRA to a Roth IRA are eliminated. At the taxpayer’s option, any IRA rollover to a Roth IRA amount that would be included as income will be included in income in equal amounts in 2011 and 2012 or the entire amount in income in 2010.
Military Exclusion from Income: Living (Basic Allowance for Housing, Basic Allowance for Subsistence, housing and cost-ofliving allowances abroad), moving allowances (dislocation, base realignment and closure benefit paid after 11 Nov. 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, spaceavailable travel on government aircraft).
IMPORTANT NOTE: The states that do not tax retired military pay are: Alabama, Alaska, Florida, Hawaii, Illinois, Kansas, Kentucky*, Louisiana, Massachusetts, Michigan, Mississippi*, Missouri*, Nevada, New Hampshire, New Jersey, New York, North Carolina*, Ohio, Oregon*, Pennsylvania, South Dakota, Tennessee, Texas, Washington, Wisconsin and Wyoming. (*With conditions).
Methods to Reduce Taxable Income:
Retirement Account(s): A member is permitted to participate in a retirement account.
a. Employer-Established Retirement Plans and Thrift Savings Plan: The elective deferral limits are $16,500. If you will be 50 years old by 31 December 2010, you may contribute an additional $5,500 (catch-up contribution). Service members who contribute to his or her TSP from their basic pay may also contribute from their incentive or special pay (including bonus pay).
b. Individual Retirement Accounts: IRA contributions, to be deductible, are subject to various limitations (filing status and “Modified Adjusted Gross Income”). Individuals can also contribute to an IRA on a non-deductible basis. In addition, deductible IRA contributions up to $5,000 (plus a $1,000 makeup allowance for those over the age of 50) may be made for each spouse (including a non-income-producing spouse) as long as the combined compensation of both spouses at least equals the contributed amount.
c. Defined Contribution Plans: The maximum amount that can be contributed to a defined contribution plan is 25% of an employee’s compensation, which is capped at a maximum of $49,000 (compensation of $245,000).
IMPORTANT NOTE: Every service member is limited to contributing a maximum of $16,500 to a combination of an Employer Retirement Account (401K, etc.) and Thrift Savings Plan. Three states (New Jersey, Massachusetts, and Pennsylvania) do not allow IRA contributions to be deducted from taxable income.
Capital Gains Tax Planning: Holding investment assets for more than one year allows a taxpayer to utilize the more favorable long-term capital gains tax rate structure. The federal tax rate on most long-term gains are 15% (taxpayers in the 25%, 28%, 33% and 35% tax brackets) and 5% (taxpayers in the 10% and 15% tax brackets).
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 Deduct ion: The 2010 amounts are: $5,700 for single or married filing separately; $11,400 for married filing jointly or qualified widow; and $8,400 for a head of household. There is no phase out in 2010.
Miscellaneous Itemized Deductions: In 2010, there is no deduction phase out. The following is a list of the available deductions and their respective limits, if any:
Itemized Deductions (Not subject to 2% limitation): These deductions consist of: Educator expense ($250 deduction if certain qualifications are met); business expenses of a Reservist; $2,500 maximum student loan interest deduction (subject to $150,000 if married filing jointly or $75,000 single or head of household AGI phase out and not available to individuals who are married and file separately); health savings account deduction; moving expenses; one-half of self-employment tax; real estate taxes (even if paid with BAH); 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 (even if paid with BAH and subject to limitations).
State and Local Sales Tax: State and local sales taxes are deductible (actual purchase amount) or pursuant to an IRScreated table. If the IRS table is used, the sales tax paid on automobiles, boats and other items specified by the IRS are also deductible.
Charitable Contributions: Contributions to a church, temple, not-for-profit organization, etc., are eligible for the deduction. Contributions made solely for recreation, amusement or welfare (MWR) of service personnel, are also 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. If you make a gift of appreciated property, you can receive a tax deduction for the property’s full market value without having to pay tax on any appreciation.
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 in the next year.
Unreimbursed Travel Expense: A Reservist traveling more than 100 miles away from home in connection with his or her performance of services as a member of the Reserves can deduct his/her unreimbursed travel expenses as an adjustment to income on line 24 rather than as a miscellaneous itemized deduction. A Reservist required to remain away from his or her principal place of employment overnight in performance of authorized drills (IDTs) and training duty (AT/ADT) may deduct all of the cost of the travel expenses, including meals (subject to 50% limitation) and lodging (if not furnished), whether or not he/she is compensated for such drills and training duty, as long as he/she is not on per diem. A Reservist who is unemployed or a student is not entitled to the mileage deduction.
Exceptions:
The business expense deduction provides eligible Reservists an above-the-line deduction for their transportation, meals and lodging expenses (non-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.
Itemized Deductions (Subject to 7.5% limitation):
Medical expenses must total at least 7.5% (10% if in AMT) of adjusted gross income (AGI) to be deductible. Deductible expenses include all unreimbursed medical expenses (doctors’, dentists,’ and chiropractors’ fees; lab fees; contact lenses and eye glasses; and medical supplies), after-tax dollars spent on insurance premiums (Medicare Part B and D premiums), copayments for drugs and treatments, acupuncture, and medical travel.
Itemized Deductions (Subject to the 2% limitation):
Out-of-Pocket Meals (Reduced By 50%): Officers may deduct their meals on Form 2106. To deduct the expense, the officer may either (1) maintain records of each meal purchased; or (2) utilize the maximum rate authorized paid by the federal government for meals and incidental expenses in the locality where the travel was performed.
Uniforms, Uniform Accessories and Maintenance: Members are allowed to list on Form 2106 all expense pertaining to the unreimbursed uniform expenses incurred. The expenses include maintenance, repair or alteration of uniforms and equipment especially required by the military, which doesn’t take the place of civilian clothing.
Professional Societies, Subscriptions to Military-Related Periodicals and Purchase of Books: The cost of membership, subscribing to military-related periodicals and the purchase of books, which enhance the training or potential of the member, 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.
Job Search Expenses: Expenses associated with a job search (résumé preparation, copying, postage, travel to interviews and long-distance calls) in the same occupation are deductible.
Other Deductible Expenses: The following expenses may also be deductible: (1) Change of Command or Change of Office, and Special Award Ceremony expenses (printing, reception, etc.); and (2) legal expenses incurred by a member in the defense of certain allegations. [IRS Publication 529, Miscellaneous Deductions.]
Additional Civilian Deductions: Home office expense (if your “principal” place of business); tax return preparation costs; job search expenses; and educational expenses (if (1) required by your employer or by law or regulations to retain your salary, status or job, or (2) to maintain or improve your skills required in your job).
Lines 38-44. Tax. This section calculates the amount of your taxable income by deducting your standard or itemized deductions from your adjusted gross income. It may also be impacted by the Kiddie Tax (Form 8814). The Kiddie Tax applies to unearned income, in excess of $900, of a child under age 19 or 24 if a full-time student. The child’s unearned income between $900 and $1,899 will be taxed at his or her marginal income tax rate (typically 10%). Income in excess of $1,900 will be taxed at the parent’s marginal tax rate.
Line 45. Alternative Minimum Tax. The alternative minimum tax (AMT) 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%. The 2010 exemption amounts are the following: $45,000 for married (filing jointly) and surviving spouses; $33,700 for single or head of household filers; and $22,500 for married (filing separately). The exemption amounts are subject to being phased out by an individual’s AMTI. The only deductions that remain available are for mortgage interest and charitable donations. Deductions are lost for state and local income taxes and property taxes, unreimbursed business expenses, child-tax credits, and home-equity loan interest.
Caution. Congress is expected to consider legislation that would increase the AMT exemption amounts shown above.
Lines 47-55. Credits. Foreign Tax Credit (Form 1116); child care (child under age 13); dependent care (physically or mentally incapable of self-care); credit for the elderly or disabled (Schedule R); and American Opportunity Credit.
Child Tax Credit. $1,000 per qualifying child under age 17. The credit is phased out for adjusted gross income levels: (1) $110,000 for joint filers; (2) $55,000 for married individuals filing separately; and (3) $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.
Adoption Credit. A $13,170 credit for each child (a special needs child receives the full credit regardless of the amount of expenses). In 2010, the adoption credit is refundable and may be claimed even if you owe no tax. The credit is phased out for taxpayers with modified AGI between $182,520 and $222,520.
Mortgage Interest Credit. Home loan mortgage interest is deductible up to $1 million in home acquisition debt. Home equity loan interest has a limit ($100,000 or $50,000 if married filing separately) on the amount of debt that can be treated as home equity debt (disallowed under AMT). Interest on amounts up to the home equity debt limit are deductible while amounts in excess are treated as personal interest and not deductible. In addition, the interest on excess equity loan amounts used for investment, business, or other deductible purposes may be deductible.
Saver’s Credit. A nonrefundable tax credit based on qualified retirement savings contributions to an employer plan made by an eligible individual (AGI of $55,500 or less on joint returns, $41,625 or less on head of household returns, and $27,750 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.
Energy-Saving Improvements. The American Recovery and Reinvestment Act (Recovery Act) expands the “nonbusiness energy property credit” (capped at $1,500 for 2010) and “residential energy efficient property credit” (no cap). The energy credits equal thirty (30%) percent of the cost of energy-saving improvements (high-efficiency heating and air conditioning systems, water heaters, energy-efficient windows, solar electric systems, solar hot water heaters, geothermal heat pumps, etc.). Taxpayers may claim both credits regardless of whether they itemize their deductions.
New Car Purchases. Taxpayers who purchase a new “qualified motor vehicle” (car, light truck, motor home or motorcycle) between 16 February 2009 and 31 December 2010, for less than $49,500, may deduct the sales and excise taxes. The deduction phases-out between $250,000 and $260,000 of modified adjust gross income for married couples and $125,000 and $135,000 for single taxpayers.
Home Buyers Credit. An $8,000 tax credit for qualified firsttime home buyers (buyer who has not owned a primary residence during the three years up to the date of purchase) and $6,500 for home purchasers who have owned and used the same home as a principal or primary residence for at least five consecutive years of the eight-year period ending on the date of purchase of a new home as a primary residence on or before 1 May 2010 (before 1 October 2010, if you entered into a written binding contract before 1 May 2010 to purchase the property before 1 July 2010). Service members on qualified official extended duty service outside of the United States, for at least 90 days and before 1 May 2010, have an extra year to buy a principal residence in the U.S. and qualify for the credit.
American Opportunity Credit. A $2,500 per student per year credit for qualified tuition, fees and books paid on behalf of a student. The credit phases out at $80,000 of Adjusted Gross Income for single filers ($160,000 for joint filers). The full credit is also allowed against the Alternative Minimum Tax. Lines 56-60. 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); non-taxable combat pay election; and household employment.
Lines 56-60. 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); non-taxable combat pay election; and household employment.
Lines 61-72. Payments. This section includes: Federal Income Tax withheld (W-2 and 1099); estimated tax payments (2010 payments and amounts applied from 2009); earned income credit (Form EIC); excess social security, medicare, and RRTA tax withheld; non-taxable combat pay election; additional child tax credit; and amounts paid with an extension request.
Lines 73-77. Refund or Amount You Owe. This section either makes taxpayers happy, if they are due a refund, or a scowl, if money is owed to the government.
The following are additional factors that must be considered when completing your 2010 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 2010.
Exclusion from Gross Income. Enlisted members or warrant officers (including commissioned warrant officers) who perform service in a combat zone will have their military pay excluded (not included as a part of their W-2 income) from their gross income for all or any part of the month of their service in a combat zone under 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 under IRC Section 112(b). Any income, dividends, interest and bonuses received from sources other than the military will not be tax exempt.
The combat zone income exemption will apply to the following: (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 he/she completed the necessary action for entitlement to the reenlistment bonus in a month during which he/she 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.
Federal and State Grants. The federal government and many states offer returning and retired veterans different types of grants. The grants come in the form of special monetary compensation (returning veteran bonus, combat zone grant, property tax rebate, aid for OIF/OEF veterans, Appreciation Fund, funds to adapt a residence for disabilities, etc.) or benefits (free college and university tuition, ad valorem tax relief, small business grants, etc.). All funds and benefits received from a federal or state grant program will be tax free to the recipient.
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 (5) 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 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. Qualification for an extension will entitle a service member to make a timely qualified retirement contribution for the prior tax year to his or her retirement account on or before the extended deadline for filing the income tax return for that year. Any amount contributed to an IRA that is more than the smaller of (1) your taxable compensation or (2) $5,000 ($6,000 if you are age 50 or over) is an excess contribution and must be withdrawn to avoid the excise tax. If your taxable compensation will be less than $5,000 ($6,000 if you are age 50 or over), you should withdraw the portion of your contribution that exceeds your taxable compensation.
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, a service member will not be required to make payments on past due taxes. Also, no additional penalties or interest will be charged during this 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 service in a combat zone is not reported on a service member’s Form W-2 in the box marked “Wages, tips, other compensation.” The military pay will be subject to Social Security and Medicare taxes and will be reported under “Social Security wages” and “Medicare wages and tips.”
Earned Income Tax Credit (EITC). The U.S. Tax Code does not include combat pay, Basic Allowance for Housing (BAH) and Basic Allowance for Subsistence (BAS) in the definition of “earned income” for purposes of the EITC. These exclusions may leave a taxpayer with no earned income and the inability to claim the credit. The credit amounts are: $3,050 if you have one qualifying child; $5,036 if you have two qualifying children; $5,666 if you have three or more qualifying children; or $457 if you do not have a qualifying child. The credit phases out at: $43,352 ($48,362 if married filing jointly) if you have three or more qualifying children; $40,363 ($45,373 if married filing jointly) if you have two qualifying children; $35,535 ($40,545 if married filing jointly) if you have one qualifying child; or $13,460 ($18,470 if married filing jointly) if you do not have a qualifying child.
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 end of hostilities and recession of the combat zone designation, 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. The exclusion will only apply to income taxes and not FICA taxes. No interest or penalties will be assessed during this period.
Dependent Children Tax Returns. No income tax return is required to be filed for a dependent child while one or more spouses serves in a combat zone. The service member’s extension to file his/her federal individual income tax return will apply.
Accrued Annual Leave. Combat zone leave payments will be excluded from gross income (subject to the maximum enlisted pay limitation). The exclusion will also apply when a service member sells back his/her leave upon separation from the military or active duty.
Reenlistment Bonus. A reenlistment bonus earned as a direct result of the completion of actions necessary for its entitlement in a combat zone will be excluded from gross income. The exclusion will apply even if the bonus is received while outside the combat zone.
MILITARY TAX DEFERAL
The Servicemembers Civil Relief Act allows Reservists called to active duty a deferral of taxes owed if they can show that their ability to pay the 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. Service members on duty outside the U.S. or Puerto Rico, but not serving in a combat zone, have until June 15 to file their taxes. Interest will accrue from the normal due (15 April) date until the time of payment.
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.
ADDITIONAL MILITARY TAX BENEFITS
Homeowners. Service members forced to sell a residence, due to being redeployed, will receive a tax break on any capital gains tax they may incur as a result of failing to meet the two-out-of-five year requirement. Housing assistance provided to service members, to compensate for a decrease in a residence’s value due to a base closure or restructuring, will also no longer constitute taxable income.
Early Retirement Account Withdrawals. Service members who are called to active duty for at least 180 days and experience financial difficulties are allowed to make penalty-free withdrawals from an IRA, 401(k) and similar tax-advantaged plans. The member will have two years, after the end of their period of military service, to repay the distribution to avoid income tax and the ten percent early withdrawal penalty.
Military Spouses Residency Relief Act. The law amends the “Servicemembers Civil Relief Act” to allow both a service member and his or her spouse to maintain his/her original state of residency every time they move. The benefit will prevent a military spouse from having to file a separate state income tax return.