Military Update: Congress ends tax break quirk
Stars and Stripes October 2, 2004
Congress has passed legislation to end a quirky reduction in tax breaks that hits lower-income military families when their servicemembers are assigned to Iraq, Afghanistan or other combat areas.
Relief from the tax break glitch was part of the Working Families Tax Relief Act of 2004, approved Sept. 23 and sent to the White House. It applies only to tax years 2004 and 2005, but it might be extended.
Last year, up to 10,000 servicemembers saw combat-zone tax exemptions lower their family income, for some by thousands of dollars. The combat-zone exemptions did so by lowering reportable income enough that families lost eligibility for the more valuable Earned Income Tax Credit.
Victims of this tax break “inversion,” as a Defense official called it, typically are lower-grade enlisted members or junior officers who are married with children, serve at least seven months in a combat zone, and have little or no other family income.
What they lose is the EITC, a refundable credit for low-income workers approved in 1975 to offset the burden of Social Security taxes and to provide an incentive to work. Income thresholds to qualify for EITC vary by family size. For example, if workers have one qualifying child, taxable income must fall below $30,338 (or $31,338 filing jointly). But they also must have some taxable income.
EITC eligibility can mean refundable tax credits which put extra cash in pockets. The maximum credit in 2003 was $4,204 for a worker with two or more children, $2,547 with one child and $382 for a childless taxpayer. It’s a more valuable tax benefit than combat tax exclusion for lower income families who pay little or no taxes any way. In combat areas, enlisted and warrant officer income is tax exempt. Officer earnings are, too, but only the first $6,315.90 each month in 2004.
Sens. Mark Pryor, D-Ark., and Montana’s Max Baucus, the ranking Democrat on the Senate Finance Committee, co-sponsored the original bill to protect EITC eligibility. Now part of the new tax law, it will allow members, if they choose, to have combat zone income count toward EITC eligibility.
Choice, here, is important because not all members lose valuable tax breaks. Some senior enlisted members and even senior officers gain income from the way combat-zone exemptions and the EITC interact. Tax-break windfalls occur if they serve only part of a year in a combat zone, leaving just enough taxable income to qualify for EITC.
The House Financial Services Committee unanimously approved Sept. 29 and sent for floor vote the Military Personnel Financial Services Protection Act (HR 5011), a bill introduced by Rep. Max Burns, R-Ga., to end the sale of high-priced securities and life insurance products to service people.
Specifically banned would be “contractual plan mutual funds” like the Systematic Investment Plan sold to more than 300,000 military personnel by First Command Financial Planning, Inc., of Fort Worth, Texas. These investment options “disappeared from the civilian market 20 years ago,” Burns said, but continue to be “pawned off on unsuspecting young service people as part of ‘approved’ savings and insurance plans.”
Sales commissions the first year are 50 percent of the amount invested. Most mutual fund investments have fees of 6 percent or less.
In July, The New York Times published a series of articles detailing abuses of military personnel by investment companies and insurers. The reporting, and on-going investigations by federal and state agencies, led to a September hearing of a House Financial Services subcommittee.
While the Burns bill would end the sale of contractual plan mutual funds, it would not invalidate existing plans.
HR 5011 also would mandate that state insurance laws be enforced on military property, eliminating a haven for unscrupulous agents to sell overpriced insurance products as investments to service people.
There is no companion bill in the Senate, making passage this year uncertain. Sen. Richard C. Shelby, R-Ala., Banking Committee chairman, has asked the Government Accountability Office to study the issue.
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