The "Use It or Lose It" Rule

The IRS has issued guidance in Notice 2008-82 detailing how military reservists who are called to active duty may avoid the "use-it-or-lose-it rule" that generally applies to unused funds in a health flexible spending account (health FSA).

The Heroes Earnings Assistance and Relief Tax Act of 2008, enacted June 17, 2008, amended Sec. 125 to provide a special rule allowing distributions of unused amounts in a health FSA to reservists ordered or called to active duty. The new rule applies to distributions made on or after June 18, 2008.

Additional Resources:

http://www.govtrack.us/congress/bill.xpd?bill=h110-6081

http://taxprof.typepad.com/taxprof_blog/2008/06/presideent-sign.html

TaxAlmanac provides one of the best articles of explanation. Here is an excerpt:

House Reaffirms Commitment to America’s Armed Forces

Bill would provide essential tax relief to military families

WASHINGTON, D.C. - The House of Representatives approved bipartisan legislation to deliver tax relief to the men and women of our nation’s armed services, as well as others volunteering in service in America. The bill, H.R. 6081, the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008, also makes a critical change to current law that will enable thousands of active duty military families to qualify for economic stimulus payments. H.R. 6081 passed the House by a vote of 403-0.

“This bill is called the HEART Act, but I would prefer to call it the thank you bill – thank you to the tens of thousands of American men and women who have responded to America’s call to fight this war and place themselves in harm’s way to serve this nation,” said Chairman Charles B. Rangel (D-NY), chief sponsor of the HEART Act. “This bill enhances their ability to get tax benefits such as the Earned Income Tax Credit, buy homes, make penalty-free withdrawals from their pension plans, access amounts held in a Flexible Savings Account, and remove other impediments that keep them from getting the relief they deserve.

“The HEART Act would also make an important change to the recently-passed stimulus bill to allow thousands of active duty military families to receive a stimulus check they were previously denied because one spouse did not have a Social Security number,” said Chairman Rangel. “This legislation corrects this injustice to ensure that our active duty military families are not disadvantaged under our tax laws.”

Both the House and Senate have passed earlier versions of the HEART Act. H.R. 6081 is an attempt to streamline provisions in those bills for final passage.

Among other things, the Heroes Earnings Assistance and Relief Tax Act of 2008 would:

Clarify that active military who file a joint tax return would be eligible for the stimulus rebate payment even if the spouse does not have a Social Security number.

Make permanent the ability to include combat pay as earned income for purposes of the Earned Income Tax Credit (EITC);

Make permanent and modify qualified mortgage bonds used to finance residences for veterans;

Modify the Uniformed Services Employment and Re-employment Rights Act (USERRA) to allow the day prior to the date of death to be treated as the date the employee returned to work for purposes of triggering payment of benefits under a qualified plan;

Permit an employer to make certain contributions to a qualified pension plan on behalf of an employee who is killed or become disabled in combat;

Make permanent the expiring Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans;

Permit recipients of military death benefit gratuities to roll over the amounts received, tax-free, to a Roth IRA or an Education Savings Account;

Provide a tax credit for small employers with respect to differential wage payments to employees who are on active military duty;

Permit members of the reserves members called to active duty to withdraw amounts held in a Flexible Spending Account (FSA) without penalty;

Extend current law excise tax for failure to comply with the mental health parity requirements for benefits for services furnished on or after the date of enactment through December 31, 2008;
Ensure fairer treatment of military families with disabled children who depend on Supplemental Security Income (SSI) payments.

Economic Stimulus Payments for Military Combat Personnel

This information is for military personnel who are serving in combat zones.

For federal tax purposes, the U.S. Armed Forces includes officers and enlisted personnel in all regular and reserve units controlled by the Secretaries of Defense, the Army, Navy and Air Force. The Coast Guard and National Guard are also included, but not the U.S. Merchant Marine or the American Red Cross.

Normally, combat pay is not counted as income and is not taxable. For the purposes of receiving an economic stimulus payment, however, military personnel serving in combat zones have the option of including their nontaxable combat pay on their 2007 or 2008 income tax returns if it helps their eligibility for the 2008 economic stimulus payments.

To receive the stimulus payment this year, combat zone personnel or their spouses must file a tax year 2007 income tax return by Oct. 15, 2008. Otherwise, they can claim the economic stimulus payment on next year’s income tax return.

Military personnel who normally would not file an income tax return because their 2007 income is not taxable can file a simple Form 1040A with the IRS if they want to receive the economic stimulus payment. They should report their nontaxable combat pay on line 40b of the Form 1040A to show at least $3,000 in qualifying income. The Department of Defense lists the amount of excluded combat pay, along with the designation, “Code Q,” in box 12 of Form W-2.

The IRS has developed Package 1040A-3, an 8-page publication containing tax tips, a sample Form 1040A and a blank Form 1040A. The package contains everything needed to file the return immediately.

Package 1040A-3 , 8-page information package

Basic Eligibility Requirements

You have, or your family has, at least $3,000 in qualifying income from, or in combination with, Social Security benefits, certain Veterans Affairs benefits, Railroad Retirement benefits and earned income. Supplemental Security Income (SSI) does not count as qualifying income for the stimulus payment.

You are not a dependent or eligible to be a dependent on someone else’s federal tax return. (The same must be true of any family members claimed on your return.)

Due to a new law change, the spouses and children of married military personnel are not required to have valid Social Security Numbers.

To Claim Your Payment

If you normally don’t file a federal tax return but must file one this year solely to claim your economic stimulus payment, you should file by Oct. 15, 2008, to ensure that you receive the payment this year. Find out where to send your tax return.

It will generally take a minimum of eight weeks after you file your return to get your stimulus payment.

Free Tax Help Available

Individuals who need to file a return this year to receive a stimulus payment may be able to take advantage of free tax preparation sites nationwide for low-income and older taxpayers.

Free File - Economic Stimulus Payment provides free tax preparation software and electronic filing for people who are submitting a return solely to receive their economic stimulus payment

The Volunteer Income Tax Assistance (VITA) program provides help to low- and moderate-income taxpayers. Call 1-800-906-9887 to locate the nearest VITA site.

IRS employees will help prepare Form 1040A returns for low-income workers, retirees, disabled veterans and others at IRS Taxpayer Assistance Centers. For a list of centers in your state and their hours of operation, Contact My Local Office.

Related Items:

IR-2008-48, Combat Pay Can Count toward Economic Stimulus Payment Eligibility
New Law: Additional Military Families to Get Stimulus Payments This Fall
Basic Information about Economic Stimulus Payments
Frequently Asked Questions
Tax Information for Members of the U.S. Armed Forces

Additional Military Families to Get Stimulus Payments This Fall

Married members of the military may receive economic stimulus payments this fall, even if their spouses or children don’t have social security numbers, following the newly-enacted HEART Act (Heroes Earnings Assistance and Relief Tax Act of 2008). Prior to this new legislation, some members of the military did not receive stimulus payments, or received a reduced amount, due to the absence of an SSN for a spouse or child.

In November, the Treasury will send checks and direct deposits to military families who qualify for these stimulus payments. The IRS estimates that there are more than 10,000 military families who will receive the additional stimulus payments. A specific time frame for the payments will be announced later this year.

"The IRS wants to make it as easy as possible for military families to get the stimulus payments authorized by the new law. People who already have filed don’t need to do anything else to get their money. We’ll do the rest,” said IRS Commissioner Doug Shulman. “We will work as quickly as possible to put these new provisions in place while making sure the rest of the stimulus payment program continues smoothly through the summer and fall."

To get a stimulus payment, eligible taxpayers must file a 2007 tax return. For married couples who have already filed a joint return, no further action is necessary. Generally, married couples qualify for an economic stimulus payment of up to $1,200, plus an additional $300 for each qualifying child younger than 17.

Because of the special challenges involved in making these newly-authorized payments, the IRS is taking the additional step of working with the Department of Defense to ensure that eligible filers get their money.

Originally, the Economic Stimulus Act of 2008, enacted in February, barred economic-stimulus payments to anyone filing a return who did not have a social security number. Returns using any number issued by the IRS, such as an individual taxpayer identification number (ITIN) were not eligible. For joint filers, this meant that both spouses must use valid social security numbers.
Those barred by the original law from receiving a stimulus payment included military members filing jointly with spouses who were ineligible to get an SSN. In addition, because they were not eligible for stimulus payments, they could not receive an additional $300 payment for each eligible child.

Married couples filing joint returns who are now eligible for stimulus payments under the new law will receive a notice from the IRS telling them the amount of their payment and the date it will be issued. Payments will be made by check or direct deposit. Those who chose direct deposit for their regular tax refund will typically get their stimulus payment by direct deposit. However, anyone who chose a refund-anticipation loan, had tax-preparation fees deducted from their refund or entered into other refund-related transactions, will get a check, instead.

The payments are based on 2007 income tax returns, including basic returns filed by eligible low-income people, solely to claim a stimulus payment. Those who have not yet filed, including members of the military who received nontaxable combat pay, should do so as soon as possible.

Related Items:

Economic Stimulus Payments Information Center
Economic Stimulus Payments: Especially for Military Combat Personnel
Tax Information for Members of the U.S. Armed Forces

Tax Help - Military Taxing

If you’re a member of the U.S. Armed Forces who serves in a combat zone, you can exclude certain pay from your income. You also have additional time to make a qualified contribution to an IRA. A combat zone is an area designated by the U.S. President by Executive Order as an area in which U.S. Armed Forces are engaging in or have engaged in combat.



Income
The following income received during service in a combat zone doesn’t have to be reported as gross income:

active duty pay earned in any month served in a combat zone

imminent danger/hostile fire pay during a month served in a combat zone

re-enlistment bonus if re-enlistment or voluntary extension occurs during a month served in a combat zone

Pay for accrued leave — the department of defense must determine the unused leave was earned during the month served in a combat zone

pay for duties as a member of the Armed Forces in clubs, messes, post and station theaters, and other non-appropriated fund activities earned during a month served in a combat zone

awards or achievement pay made for a suggestion or achievement made in a month served in a combat zone

Student loan repayments if the entire year of service required to earn the repayment was performed in a combat zone

If you're a commissioned officer (other than a commissioned warrant officer), the combat pay exclusion for any month is limited to the highest rate on enlisted pay (plus hostile fire/imminent danger pay, if any).

You do not claim an exclusion for combat pay on your tax return. The excludable amount should not be included in your Box 1 wages on Form W-2. If an excludable amount is included in your Box 1 wages, you should get a corrected Form W-2.

If you served in a combat zone for 1 or more days during a particular month, you’re allowed the above exclusions for that entire month. Combat zone service includes any periods you are absent from duty due to illness, wounds or leave. A person is considered to be serving in a combat zone if he or she becomes a prisoner of war or is missing in action if that status is kept for military pay purposes.

You can also exclude military pay earned while hospitalized (you don’t have to be hospitalized in the combat zone). Your hospitalization must be due to having served in a combat zone. This is true even if you’re hospitalized after combat zone service. For more information, check with a tax professional.


Combat Zone Considerations

Military service outside the combat zone is, for tax purposes, considered to be inside a combat zone if the service is in direct support of combat zone military operations and the service qualifies you for special military pay for duty subject to hostile fire or imminent danger.

But in these situations, you’re not considered to be in a combat zone:
You’re present in a combat zone during leave from a duty station located outside the combat zone.

You pass over or through a combat zone during a trip between 2 points which are outside a combat zone.
You’re in a combat zone only for your personal convenience.


Hazardous Duty Areas

Members of the Armed Forces who serve outside a hazardous duty area in support of operations in a hazardous duty area are treated as serving in a combat zone only for the purpose of getting an extension. Meeting additional requirements may entitle you to full combat zone tax benefits.

Tax Help - Armed Services

If you’re a member of the U.S. Armed Forces who serves in a combat zone, you can exclude certain pay from your income. You also have additional time to make a qualified contribution to an IRA. A combat zone is an area designated by the U.S. President by Executive Order as an area in which U.S. Armed Forces are engaging in or have engaged in combat.

Income

The following income received during service in a combat zone doesn’t have to be reported as gross income:

• active duty pay earned in any month served in a combat zone
• imminent danger/hostile fire pay during a month served in a combat zone
• re-enlistment bonus if re-enlistment or voluntary extension occurs during a month served in a combat zone
• Pay for accrued leave — the department of defense must determine the unused leave was earned during the month served in a combat zone
• pay for duties as a member of the Armed Forces in clubs, messes, post and station theaters, and other non-appropriated fund activities earned during a month served in a combat zone
• awards or achievement pay made for a suggestion or achievement made in a month served in a combat zone
• Student loan repayments if the entire year of service required to earn the repayment was performed in a combat zone

If you're a commissioned officer (other than a commissioned warrant officer), the combat pay exclusion for any month is limited to the highest rate on enlisted pay (plus hostile fire/imminent danger pay, if any).

You do not claim an exclusion for combat pay on your tax return. The excludable amount should not be included in your Box 1 wages on Form W-2. If an excludable amount is included in your Box 1 wages, you should get a corrected Form W-2.

If you served in a combat zone for 1 or more days during a particular month, you’re allowed the above exclusions for that entire month. Combat zone service includes any periods you are absent from duty due to illness, wounds or leave. A person is considered to be serving in a combat zone if he or she becomes a prisoner of war or is missing in action if that status is kept for military pay purposes.

You can also exclude military pay earned while hospitalized (you don’t have to be hospitalized in the combat zone). Your hospitalization must be due to having served in a combat zone. This is true even if you’re hospitalized after combat zone service. For more information, check with a tax professional.

Combat Zone Considerations

Military service outside the combat zone is, for tax purposes, considered to be inside a combat zone if the service is in direct support of combat zone military operations and the service qualifies you for special military pay for duty subject to hostile fire or imminent danger.

But in these situations, you’re not considered to be in a combat zone:

1. You’re present in a combat zone during leave from a duty station located outside the combat zone.
2. You pass over or through a combat zone during a trip between 2 points which are outside a combat zone.
3. You’re in a combat zone only for your personal convenience.

Hazardous Duty Areas

Members of the Armed Forces who serve outside a hazardous duty area in support of operations in a hazardous duty area are treated as serving in a combat zone only for the purpose of getting an extension. Meeting additional requirements may entitle you to full combat zone tax benefits.

S. Raines, Sr. Financial Advisor/Tax Preparer