35.4 Tax-Free Pay for Service in Combat Zone
If your grade is below commissioned officer and you serve in a designated combat zone during any part of a month, all of your qualifying military pay (see below) for that month is excluded from your taxable income. You may also exclude military pay earned during any part of a month that you are hospitalized as a result of wounds, disease, or injury incurred in a combat zone. The exclusion for military pay while hospitalized does not apply to any month that begins more than two years after the end of combat activities in that combat zone. Your hospitalization does not have to be in the combat zone.
Filing Tip
Officers.
If you are a commissioned officer, you may exclude up to the highest rate of basic pay at the highest pay grade that enlisted personnel receive per month plus any hostile fire/imminent danger pay received for each month during any part of which you served in a combat zone or were hospitalized as a result of the combat zone service.
If you are a commissioned warrant officer, you are considered an enlisted person.
What is included as tax-free combat pay?
The following pay received as a member of the U.S. Armed Forces qualifies for tax-free treatment: (1) active duty pay earned in any month you served in a combat zone; (2) imminent danger / hostile fire pay; (3) a reenlistment bonus if the voluntary extension or reenlistment occurs in a month you served in a combat zone; (4) pay for accrued leave earned in any month you served in a combat zone (the Department of Defense must determine that the unused leave was earned during that period); (5) pay received for duties as a member of the Armed Forces in clubs, messes, post and station theaters, and other nonappropriated fund activities. The pay must be earned in a month you served in a combat zone; (6) awards for suggestions, inventions, or scientific achievements you are entitled to because of a submission you made in a month you served in a combat zone; and (7) student loan repayments earned for military service. For each month of combat zone service during the year, 1/12 of the repayment for that year is considered tax-free combat zone pay.
Service in the combat zone includes any periods you are absent from duty because of sickness, wounds, or leave. If, as a result of serving in a combat zone, you become a prisoner of war or missing in action, you are considered to be serving in the combat zone as long as you keep that status for military pay purposes.
Retirement pay and pensions do not qualify for the combat zone exclusion. According to a Fourth Circuit Court of Appeals decision, a Navy severance pay package was taxable although the recipient became entitled to the payment while on active duty in the Persian Gulf. The court differentiated the package, which was provided in order to entice the man to leave the service, from a reenlistment bonus provided as compensation for active service.
Law Alert
Combat zones.
A combat zone is any area the President of the United States designates by Executive Order as an area in which the U.S. Armed Forces are or have engaged in combat. An area becomes and ceases to be a combat zone on the dates designated by the President. At the time this book went to press, the following designations were still in place. For any changes, see IRS Publication 3 and tax form instructions.
The following Arabian Peninsula Areas (including airspace) have been designated combat zones since January 17, 1991: the total land areas of Iraq, Kuwait, Saudi Arabia, Oman, Bahrain, Qatar, and the United Arab Emirates; the Persian Gulf; the Red Sea; the Gulf of Oman; the part of the Arabian Sea that is north of 10 degrees north latitude and west of 68 degrees east longitude; and the Gulf of Aden.
Afghanistan, including the airspace above, was designated a combat zone beginning September 19, 2001.
Effective March 24, 1999, the Kosovo area was designated a combat zone including: the Federal Republic of Yugoslavia (Serbia/Montenegro), Albania, the Ionian Sea north of the 39th parallel, and the Adriatic Sea. Airspace above these areas is also part of the zone.
Qualifying service outside a combat zone considered combat zone service.
Military service outside a combat zone is considered to be performed in a combat zone if: (1) the service is designated by the Defense Department to be in direct support of military operations in the combat zone, and (2) the service qualifies you for special military pay for duty subject to hostile fire or imminent danger. Military pay received for this service will qualify for the combat zone exclusion if the other requirements are met.
Nonqualifying service.
The following military service does not qualify as service in a combat zone: (1) presence in a combat zone while on leave from a duty station located outside the combat zone; (2) passage over or through a combat zone during a trip between two points that are outside a combat zone; and (3) presence in a combat zone solely for your personal convenience. Such service will not qualify you for the pay exclusion.
Hospitalized while serving in a combat zone or after leaving a combat zone.
If you are hospitalized while serving in a combat zone, the wound, disease, or injury that is the reason for the hospitalization will be presumed to have been incurred while serving in the combat zone unless there is clear evidence to the contrary. The presumption may also apply if you were hospitalized after leaving a combat zone.
Form W-2.
The wages shown in Box 1 of your Form W-2 should not include combat pay. Retirement pay is not combat pay.