T he Military Family Tax Relief Act of 2003, enacted on Veterans Day, Nov. 11, 2003, is, as its name implies, focused on tax relief for military personnel.
There are, however, a number of aspects to it that could give it a broader application, and tax practitioners will want to make sure that they are familiar with those provisions even if they do not normally represent military clients.
Some of the provisions have retroactive applications, one as far back as 1997, and could affect clients who were formerly in the military but are not now. One of the provisions would primarily impact the survivors of deceased military personnel, which could encompass not only spouses or children, but also parents or siblings.
Another provision is directed at National Guard and reserve personnel, for whom the military connection may not be readily apparent to a tax advisor unless they remember the military pay appearing each year on the client’s tax return.
As with any new tax law, it is best to gain at least enough familiarity with its provisions to make sure that you understand how it may affect your clients, even if those effects are not immediately obvious.
Sale of a residence
The normal five-year period available to taxpayers to meet the two-year ownership and use test for the home sale exclusion is suspended for up to an additional 10 years to include any period during which the service person, or her spouse, is on qualified official extended duty. This provision is retroactive to the original effective date — sales after May 6, 1997.
If the tax year is otherwise closed for filing an amended return, or if the claim for the exclusion has previously been filed and denied by the courts, this legislation still gives taxpayers until Nov. 10, 2004, to make a claim for any tax paid on home sale gain that now would qualify for exclusion.
Transition rules passed as part of the Taxpayer Relief Act of 1997 make it likely that residences owned on Aug. 5, 1997, and sold prior to Aug. 4, 1999, would have qualified for the full exclusion even if military duties had kept the taxpayer or spouse away from the residence during part of that period.
Death gratuities
Military compensation laws include a death gratuity that is payable to the survivors of service personnel who die in the line of duty. The maximum death gratuity payment is increased by this law from $6,000 to $12,000. The law also provides a tax exclusion for these payments. Due to a quirk in the law going back to 1991, although the maximum death gratuity was $6,000, the maximum exclusion was $3,000. This act restores a full exclusion for the death gratuity by increasing the maximum exclusion from $3,000 to $12,000.
This provision is retroactive to deaths occurring after Sept. 10, 2001. Therefore, survivors may not only be entitled to additional gratuities beyond those that they have already received, but are also entitled to an additional exclusion, both for the new amounts to which they are entitled and for death gratuities that they may have already received with respect to deaths occurring after Sept. 10, 2001.
The increased exclusion for death gratuities received
in 2001 or 2002 may require amending returns for those years. Additional gratuities received now with respect to deaths occurring in those years would qualify for exclusion on the current year’s return.
Under the law, these death gratuities are paid first to the surviving spouse, if any, and then to the children in equal shares. Absent a spouse or children, the payments could also be made to parents or siblings, either according to directions left by the deceased person or as specified in the law.
Guard and reserves travel
Unreimbursed expenses of reservists traveling to meet their reserve obligations have been, like other employee expenses, deductible as a miscellaneous itemized deduction on Schedule A. This act creates a new above-the-line deduction for these expenses when the individual is required to travel more than 100 miles from home.
The deduction is limited to the general federal per diem rate applicable to the particular location involved. This provision applies to amounts paid or incurred in tax years beginning after Dec. 31, 2002.
Tax return preparers may be able to check for military pay reported on prior years’ returns to provide a list of taxpayers likely to be affected by this provision. Alerting affected taxpayers as soon as possible to this change might help to insure that records are preserved for expenses.
Other military provisions
A new exclusion is provided for compensation payments made under existing law to military homeowners forced to sell in housing markets depressed by announced base closings or cutbacks. This exclusion is limited to the reduction in the fair market value of the property and is effective for payments made after Nov. 11, 2003.
The new law also clarifies that military dependent care assistance programs are qualified military benefits that are not included in gross income for tax years beginning after Dec. 31, 2002. No inference is intended to be created with regard to the appropriate tax treatment of such assistance in earlier years.
Adding to the list of taxpayers who qualify for suspension of tax filing requirements while serving in a designated combat zone, the legislation expands the suspension rules to apply to participants in operations designated as contingency operations or that become contingency operations. The list had already included armed forces personnel and individuals acting in support of armed forces personnel, such as Red Cross personnel, accredited correspondents and civilian personnel who are engaged in support activities. The addition applies for any tax deadline that had not expired as of Nov. 11, 2003.
Finally, the new law permits penalty-free withdrawals from Coverdell Education Savings Accounts and Code Sec. 529 plans where the beneficiaries receive appointments to service academies.
Other provisions
More tangentially related to the military is a provision expanding the membership criteria for veterans’ organizations to preserve their tax-exempt status. Also included in the new law is a provision permitting the Internal Revenue Service to suspend the tax-exempt status of an organization that is designated as a terrorist organization without going through the normal procedural hurdles.
The act expands the list of victims who qualify for income and estate tax relief under the Victims of Terrorism Act of 2001 to include astronauts who lose their lives in the line of duty after Dec. 31, 2002, which would include the Columbia disaster.
To pay for the projected 10-year, $1.2 billion cost of the tax benefits, customs user fees for passenger and conveyance processing and merchandise processing have been extended through March 1, 2005.
Summary
The Military Family Tax Relief Act of 2003 will provide significant additional benefits to military personnel. Even tax practitioners who do not customarily serve military clients will want to become familiar with many of the provisions. Several have retroactive effective dates or possible application to former military personnel, civilians who are also members of the National Guard or reserves, or otherwise affected individuals or organizations.
