Military service members receive numerous tax exclusions that civilians do not. Compensation received while serving in a designated combat zone is excluded from federal income tax. Basic allowance for housing, basic allowance for subsistence, and most other military allowances are excluded from gross income. VA disability benefits are completely tax-free. Moving expenses for permanent change of station orders remain deductible for service members even after TCJA eliminated the moving expense deduction for civilian employees. And service members in combat zones receive extended deadlines for filing returns and paying taxes. Understanding these provisions ensures service members - and their families - are not overpaying federal income tax.
Combat zone pay (§112): All compensation received by an enlisted member (or warrant officer) while serving in a designated combat zone is excluded from gross income. Officers are limited to the highest enlisted pay plus hostile fire pay. Combat zone designations are made by Presidential Executive Order.
BAH and BAS (§134): Basic allowance for housing and basic allowance for subsistence are qualified military benefits excluded from gross income under §134. These allowances are not included in W-2 Box 1 wages. Similarly excluded: uniform allowances, travel allowances, certain reenlistment bonuses, and ROTC educational allowances.
VA disability compensation: Disability compensation received from the Department of Veterans Affairs is excluded from gross income under §104(a)(4). This includes disability pensions, service-connected disability payments, and dependency and indemnity compensation to surviving spouses and dependents.
The Tax Cuts and Jobs Act suspended the moving expense deduction and the moving expense reimbursement exclusion for most taxpayers from 2018 through 2025. However, TCJA specifically preserved both the deduction (Form 3903) and the exclusion for members of the Armed Forces on active duty who move pursuant to a military order involving a permanent change of station. Under OBBBA, the military moving expense provisions remain in effect. A service member who receives a PCS order and incurs moving expenses can deduct those expenses (or exclude employer/government reimbursements) regardless of the general suspension of the civilian moving expense rules.
The Servicemembers Civil Relief Act (SCRA) provides important income tax protections. Under SCRA, a service member's state of domicile for income tax purposes remains the state where they were domiciled when they entered military service - not the state where they are currently stationed. A soldier domiciled in Florida who is stationed in California does not owe California income tax on military compensation. The SCRA protection applies to the service member's compensation but not to civilian income earned in the state of assignment (a service member's spouse who works in California does owe California income tax on those wages).
Normally, excluded income does not count as earned income for purposes of the Earned Income Tax Credit. But service members with combat pay may elect under §32(c)(2)(B) to include their otherwise-excluded combat pay as earned income for EITC calculation purposes. This election can significantly increase the EITC for lower-income service members whose combat pay exclusion would otherwise reduce their EITC-qualifying earned income below the optimal level. The election is beneficial when the EITC increase from including combat pay exceeds the income tax cost of including it. Run the calculation both ways before making the election.