Get to know the authorAs a member of the US military serving overseas, you’re already juggling countless responsibilities. The last thing you need is a tax headache in the filing season.
But here’s some good news: Combat Zone Tax Exclusion could be your way to significant tax savings.
Curious about how much of your pay while in service could be tax-free? Or wondering if you even qualify for this exclusion? In this article, we’ll cover the ins and outs of Combat Zone Tax Exclusion and how it can benefit you financially as a member of the US armed forces.
What is Combat Zone Tax Exclusion?
The Combat Zone Tax Exclusion (CZTE) is a special tax break that offers financial relief to US service members who serve in designated combat zones. It allows eligible military personnel to exclude a portion or all of their military pay from their taxable income. This means less money owed to the IRS on their tax bill in exchange for their service on the front lines of US military operations.
Recognizing the unique sacrifices made by those serving, Congress originally enacted the CZTE back in 1918 as a way to show appreciation and provide tangible support. It’s been a cornerstone of military tax benefits for decades, evolving over time to adapt to changing circumstances.
The CZTE is a lifeline for many service members. With the pressures of deployment, from separation from loved ones to the inherent risks of the job, having a tax break offers some ease when it comes to financial burdens.
- More take-home pay: The most obvious benefit of the exclusion is an increased disposable income. Every dollar saved on income tax is a dollar that can go towards living expenses such as rent, groceries, or childcare.
- Reduced tax filing stress: Calculating taxes can be complex, especially for service members with deployments. The CZTE simplifies the process, reducing paperwork and potential errors.
Eligibility criteria — who qualifies?
To claim the Combat Zone Tax Exclusion (CZTE), you must meet specific criteria related to your service location, the nature of your service, and other criteria.
- Designated combat zones and contingency operations: The first step to qualifying for the CZTE is serving in a designated combat zone or contingency operation. These areas are determined by the US government and are subject to change. Examples of past combat zones include Iraq, Afghanistan, and Kuwait.
- Length of service requirements: Even short-term deployments might qualify you for an exclusion. The exact requirements can vary based on the specific combat zone and the type of service performed. The exclusion applies to any period you served in a designated combat zone, even if it was just for one day within a month, for example.
- Types of pay and allowances covered: Not all types of military pay are eligible for the CZTE. Generally, base pay, housing allowance, and subsistence allowance are excludable. However, bonuses, special pay, and other allowances might have specific limitations. It’s essential to understand which types of pay qualify for the exclusion to maximize your tax benefits.
The amount you can exclude depends on your military rank:
- Enlisted members and warrant officers can exclude all of their military pay for each month served in the combat zone.
- Commissioned officers are limited to the highest rate of enlisted pay plus any imminent danger/hostile fire pay for each month in the combat zone.
Here, you can see the list of organizations whose members are eligible for this tax benefit.
Note:
If both you and your spouse served in a combat zone, you can claim the exclusion for the months you were present. If only one of you was in the combat zone, that individual can claim the exclusion.
Nonqualifying presence in a combat zone
Nonqualifying presence in a combat zone refers to periods when a service member is physically located in a designated combat zone but doesn’t qualify for the Combat Zone Tax Exclusion (CZTE).
This typically occurs in the following situations:
- Leave from a duty station outside the combat zone: If a service member is stationed outside a combat zone and takes leave to visit the combat zone, that time is generally not considered qualifying service for the CZTE.
- Passing through a combat zone: If a service member is traveling between two locations outside a combat zone and merely passes through the combat zone, they can typically exclude that time as well.
- Presence in the combat zone solely for personal convenience: If a service member is in a combat zone for personal reasons unrelated to their military duties, that time does not qualify for the CZTE.
Note:
It's important to note that there might be exceptions to these general rules, and specific circumstances should always be reviewed carefully.
How the Combat Zone Tax Exclusion works
Understanding how you calculate and apply the Combat Zone Tax Exclusion (CZTE) can help you maximize your tax benefits. Let’s break it down.
The first step is determining your eligible income. This generally includes the following:
- Basic pay: You can exclude every dollar you earn while in the combat zone
- Bonuses: Reenlistment or continuation bonuses earned while in the combat zone are tax-free
- Student loan repayments: You can exclude a portion of student loan payments made on your behalf by the US government, depending on your length of service
- Imminent danger pay: You can exclude the total amount of this portion of your income
- Leave benefits: Cashing out accrued leave earned in the combat zone is eligible for exclusion
- Awards and incentives: You can exclude money earned for award or incentive submissions made while in the combat zone
Social Security and Medicare taxes on combat zone pay still apply and will be withheld automatically from your pay, and appear on your W-2 at the end of the tax year.
Let’s say you’re an enlisted soldier deployed to a combat zone for six months. Your monthly pay is $4,000. Thanks to the CZTE, you can exclude all $4,000 for each of those six months from your taxable income, resulting in significant tax savings.
Note:
The exclusion is prorated based on the number of qualifying days in the combat zone.
Reporting combat zone income on tax returns
First and foremost, you’ll need to gather all the necessary documentation to support your claim for Combat Zone Tax Exclusion (CZTE). This typically includes copies of your military orders, leave and earnings statements, and any other relevant pay stubs or records. Having these on hand will make the filing process a breeze.
Now, on your tax return, you’ll want to enter the specific combat zone location and dates of your deployment in the designated fields. This ensures the IRS can easily identify your eligible income and apply the exclusion correctly.
Now, a word of caution. You should be vigilant about avoiding common mistakes when claiming CZTE.
For instance, don’t accidentally include combat zone income on the wrong line of your return. This could trigger unnecessary questions or delays from the IRS. Similarly, remember that you can’t claim the CZTE and the Foreign Earned Income Exclusion on the same income (wages paid by the US government are not eligible for the FEIE).
Note:
There is special tax forgiveness for military members who, while serving in a combat zone, are impacted by wounds, disease, death or injury during their time in a combat zone. The entire year's income is tax-free for the deceased service member's tax year in which they died, including all income earned prior to the date of death, including military death benefits. The tax forgiveness extends to the deceased's spouse and dependent children as well, which can provide significant financial relief to the family during an extremely difficult time.
Additional tax considerations for military expats
While the Combat Zone Tax Exclusion is a valuable benefit, it’s just one piece of the puzzle when it comes to military expat taxes.
If you’re serving in a combat zone, you automatically receive an extension on your tax filing deadline. This gives you up to 180 days, approximately six months, after leaving the combat zone to submit your Federal tax return. But don’t wait until the last minute — keep track of your deployment dates and locations to prepare accordingly.
Also, your state tax obligations don’t disappear just because you’re overseas. Depending on your state of tax residence before you deploy, you may still need to file a state return and pay applicable taxes, even if your combat zone income is excluded from federal taxes.
A note for contractors — according to the IRS, “contractors or employees of contractors supporting the US Armed Forces in designated combat zones, also may qualify for the foreign earned income exclusion.”
Remember:
The Combat Zone Tax Exclusion only applies to your income earned while physically present in a designated combat area. Any other earnings, whether from investments, side hustles, or non-combat military pay, will be subject to regular tax rules. Be sure to report this income accordingly.
