How the Combat Pay Exclusion Works
Earned income is money you get from working, such as wages or taxable military pay. An exclusion is income you can leave out of your gross income, so it isn’t taxed. Excluded pay also stays out of your adjusted gross income (AGI), which is your total income minus certain adjustments.
The combat pay exclusion applies to months you serve in an IRS-designated combat zone. A current list of combat zones is kept by the IRS.
What Enlisted Members Can Exclude
If you’re an enlisted member, warrant officer, or commissioned warrant officer, the Armed Forces’ Tax Guide lets you exclude:
- Active duty pay earned in any month you served in a combat zone
- Imminent danger or hostile fire pay
- A reenlistment bonus, if you reenlisted in a month you served in a combat zone
- Pay for accrued leave earned in a month you served in a combat zone
Limits for Commissioned Officers
Commissioned officers other than commissioned warrant officers have a capped exclusion. You can exclude up to the highest rate of enlisted pay, plus any imminent danger or hostile fire pay. This applies to each month you spent any time in a combat zone or were hospitalized as a result. Publication 3 lists the current monthly cap.
Where Combat Pay Shows Up on Your W-2
Ordinarily, you don’t have to do anything to claim the exclusion. It’s already reflected on your W-2.
| W-2 box | What it shows |
|---|---|
| Box 1 | Taxable wages, which shouldn’t include excluded combat pay |
| Box 12, code Q | Your nontaxable combat pay |
You’ll need the box 12 figure if you decide to count combat pay for the EITC.
Counting Combat Pay as Earned Income for the EITC
The earned income tax credit (EITC, also called the EIC) is a tax credit tied to the income you earn from work. A tax credit reduces the tax you owe. Here’s how tax credits work.
You don’t have to count nontaxable combat pay as earned income. If you choose to include it, you may owe less tax and get a larger refund.
Rules for the Election
- If you include combat pay, you must include all of it.
- Spouses can each choose on their own. One can include all of theirs while the other includes none, or you can both include it or both skip it.
You report the election on Form 1040 or 1040-SR, line 1i.
When Including Combat Pay Helps
Publication 3 offers an example of a married couple with one child. Gray earned $5,000 in taxable wages plus $10,000 in combat pay, and Gray’s spouse earned $2,000. Counting the combat pay increased their credit, so they entered $10,000 on line 1i.
In a second example with $35,000 of combat pay, the election didn’t increase the credit. That’s why the IRS suggests you figure your credit both ways and pick the better result.
Combat Pay Counts Toward IRA Limits
An individual retirement arrangement (IRA) is a tax-advantaged retirement account. For IRA purposes, compensation includes nontaxable combat pay. You include it when figuring your limits on IRA contributions and deductions, even though it isn’t in your gross income.
