Most military taxpayers are aware of the combat zone exclusion, but they are unaware of the rules and restrictions placed on the exclusion and who actually qualifies for the exclusion.
If a person is a member of the U.S. Armed Forces who serves in a combat zone, then the person can generally exclude certain pay combat pay from their income. However, a member of the U.S. Armed Forces must actually be a member of the United States military and not a contractor for the military.
The following is a small list of the types of combat pay that is tax free for enlisted members, warrant officers, or commissioned warrant officers:
- Active duty pay earned in any month served in a combat zone
- Imminent danger or hostile fire pay
- A re-enlistment bonus if the voluntary extension or re-enlistment occurs in a month served in a combat zone
- Pay for accrued leave earned in any month served in a combat zone
- Student loan repayments if the entire year of service required to earn the payment was performed in a combat zone
The most common combat zones are the areas of Afghanistan, Kosovo, the Persian Gulf, or any other area the President designates by Executive Order as an area in which the U.S. Armed Forces are engaging or have engaged in combat.
A military taxpayer’s combat zone exclusion pay should not be included in their Box 1 of Form W-2. If the combat zone exclusion pay is included in the taxpayer’s Form W-2, then the taxpayer should get a corrected Form W-2 from their finance office. All wages shown in Box 1 of Form W-2 are generally taxable.