Affected by the new UDC Laws?
Child Credit Increases
Marriage Penalty Relief
Increased AMT Exemption
Energy Tax Incentives Act of 2005
American Jobs Creation Act of 2004
Working Families Tax Relief Act
Military Family Tax Relief Act of 2003
State Tax Law Related to Military


Are you affected by the new UDC Laws?
How will the UDC affect your tax return this year? With the new rules, you could qualify to receive more tax benefits.

What is it?
Having a qualifying child may enable you to claim several tax benefits, such as head of household filing status, the exemption for a dependent, the Child Tax Credit, the Child and Dependent Care Credit and the Earned Income Tax Credit. Prior to 2005, the IRS defined a qualifying child differently for each of these tax benefits. Now, with the new UDC rules, the same age, relationship, residency status, support and other qualifications apply to all benefits. This makes it much easier to know what you're qualified to receive.

What defines a qualifying child?
A child is considered to be qualified if he or she meets the following conditions:

  • Relationship - The child must be your child or stepchild (whether by blood or adoption), foster child, sibling or stepsibling, or a descendant of one of these.
  • Residence - He or she must live with you for more than half the tax year. Some exceptions apply for children of divorced or separated parents, kidnapped children, temporary absences, and for children who were born or died during the year.
  • Age - He or she must be under the age of 19 at the end of the tax year, or under the age of 24 if a full-time student for at least five months of the year. Or, if the child is permanently and totally disabled at any time during the year, he or she qualifies.
  • Support - The child cannot provide more than half of his or her own support for the year.
  • Citizenship - The child must be a U.S. citizen or resident. Or, they can be a resident of Canada or Mexico.

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Child Credit Increases to $1,000 for 2003 and 2004
The bill increases the child tax credit from $600 to $1,000 per child for tax years 2003 and 2004. The 2003 increase will be paid in advance (similar to the "rebate" provided for under the 2001 Tax Act). Eligibility for the advance payment will be based on the 2002 return. Currently, the phase out of the child tax credit begins at:

  • $55,000 for Married Filing Separately filing status;
  • $75,000 for Single, Head of Household, and Qualifying Widow(er)
  • $ 110,000 for Joint filers

Unlike most phase out provisions, the end of the phase out range is not fixed. The maximum credit is reduced by $50 for each $1,000 of income above the phase out starting point. A credit amount of $600 per child means that the phase out range increases by $12,000 for each child ($600/50 x $1,000). A credit amount of $1,000 per child means that the phase out range increases by $20,000 for each child.

Example: Under previous law, the credit was completely phased out for a married couple with three children at $146,000 ($110,000 + $36,000). Under the new law, the credit is available until their income reaches $170,000 ($110,000 + $60,000).

Who Benefits?
The actual benefit of an increase to the child tax credit depends on the taxpayer's tax liability, earned income, and the number of qualifying children. For a typical family with two children, the maximum benefit is $800. Some or all of the child tax credit may be refundable. However, the rules for determining the refundable amount mean that individuals with earned incomes less than $22,500 will not benefit from this proposal.

Our Advice
The biggest question for all taxpayers: Who gets the check? The IRS is sending out letters beginning in July 2003 to inform taxpayers about the status of their advanced payment check. Most taxpayers who claimed the Child Tax Credit on last year's return will get a check from Uncle Sam this summer. The check is an advance payment of the new tax law's 2003 increase in the Child Tax Credit. Taxpayers, who claimed the credit on their 2002 tax return, may be eligible for up to $400 for each qualifying child.

Why $400?
That's the difference between the 2002 maximum credit of $600 and the increased 2003 amount of $1,000.
If you have had a significant change in the status of qualifying children since April 2003, such as a divorce, you may need professional tax help to make the most of your new tax situation.

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Marriage Penalty Relief for 2003-2004
A "marriage penalty" occurs when married taxpayers pay more tax than they would have as single taxpayers. The 2001 Tax Act included several provisions intended to reduce or eliminate various aspects of the marriage penalty. Two of the provisions increased the size of the 15% tax bracket for joint filers and the amount of the joint standard deduction to double the amounts for single filers. These are currently scheduled to occur in steps from 2005 to 2008. The following changes are effective for 2003 and 2004.

Expansion of the Married Filing Jointly 15% Tax Bracket
Using the 2003 Married Filing Jointly tax rate schedule, the 15% rate bracket ends at $56,800 ($28,400 x 2), rather than $47,450. Disregarding the reduction of the 27% rate to 25%, married taxpayers could pay up to $1,122 (($56,800 - $47,450) x (27%-15%)) less in taxes.
Note: The Married Filing Jointly tax rates are used by Qualifying Widowers and the Married Filing Separately brackets are half of the Married Filing Jointly brackets, so these taxpayers also benefit from this change.

Increase the Married Filing Jointly Standard Deduction
This provision makes the standard deduction on Married Filing Jointly returns twice the amount allowed for Single filers. This change was scheduled to be phased in over a five-year period beginning in 2005. For 2003, the new law increases the standard deduction from $7,950 to $9,500. This change primarily affects joint filers who do not itemize. However, many taxpayers may no longer need to file Schedule A because their itemized deductions do not exceed $9,500.

Our Advice
Now that the standard deduction for Married Filing Jointly taxpayers is double that of Single Filers, there's not as much of a need to worry about itemizing. (You should still keep good records, however!) Now, married couples may find that taking the standard deduction really pays off. It's simpler and may actually result in a bigger deduction.

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Increased AMT Exemption for 2003 and 2004
The 2001 Tax Act temporarily increased the alternative minimum tax (AMT) exemption by $2,000 ($4,000 for joint filers) for tax years 2001-2004. The 2003 exemption amount was $35,750 ($49,000 Married Filing Jointly). Under the new law, the exemption is increased $40,250 ($58,000 Married Filing Jointly).

Who Benefits?
Those who were affected by the AMT in the past might be better off than before. The maximum potential benefit is $1,260 ($2,520 Married Filing Jointly).

Our Advice
Individuals planning to exercise and hold incentive stock options should visit with their tax professional to discuss how to plan for the AMT and take advantage of the increased AMT exemption.

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Energy Tax Incentives Act of 2005
Alternative Technology Vehicles

  • Description: A nonrefundable credit for the purchase of fuel efficient vehicles. The vehicle must be certified by the Treasury Department as qualifying for the credit. The following vehicle types are included in this provision
  • Hybrid vehicle: A hybrid vehicle uses both gas and electricity to propel the vehicle. Several auto manufacturers including Toyota, Honda, and Ford manufacture hybrid vehicles.
  • Fuel cell vehicle: A fuel cell vehicle uses hydrogen as its main source of power.
  • Advanced lean burn vehicle: This type of vehicle has a combustion engine designed to use more air than necessary for complete combustion of the fuel.
  • Alternative fuel motor vehicle: This automobile is deigned to use compressed or liquefied natural gas, liquefied petroleum gas, hydrogen, or other qualifying fuel. Hybrid vehicles may qualify under this definition. Electric vehicles that qualify for the electric vehicle credit are specifically excluded from the definition, however.

Credit Amount:

  • Hybrid vehicle: $400 to $2,400 depending on fuel economy plus a conservation credit of $250 to $1,000 based on lifetime fuel savings. This credit replaces the clean-fuel "hybrid" vehicle deduction.
  • Fuel cell vehicle: $8,000 to $40,000 depending on the weight of the vehicle plus $1,000 to $3,000 based on fuel efficiency. Hydrogen vehicles are not yet available for purchase.
  • Advanced lean burn vehicle: The credit is calculated in the same manner as the hybrid vehicle credit.
  • Alternate fuel motor vehicle: $5,000 to $40,000 depending on fuel economy of the vehicle. A reduced credit is available for vehicles that use both a qualifying alternative fuel and gasoline.

Effective Date: Starts in tax year 2006. Hybrid, lean burn diesel, and other qualifying vehicles must be purchased before 2011 (2010 for hybrid vehicles that weigh more than 8,500 pounds). Fuel cell vehicles must be purchased before 2015.

Residential Energy Efficient Property
Description: A nonrefundable tax credit for the purchase of solar water heating, photovoltaic equipment, and fuel cell property for use in the taxpayer's personal residence. (Fuel cell property must be installed in taxpayer's principal residence.) Qualifying property must provide an energy source for the entire house. Costs related to swimming pools, hot tubs, or other properties that can be used for any purpose other than energy storage do not qualify.

Credit Amount is the sum of 30% of expenditures up to:

  • $2,000 for photovoltaic property
  • $2,000 for solar water heating property
  • $500 per half kilowatt of capacity for fuel cell property

Effective Date: 2006 and 2007

Non-business Energy Property

Description: A nonrefundable credit for the purchase of energy-efficient improvements to existing homes located in the U.S. Qualifying property includes insulation, windows, doors, furnaces, hot water heaters, and heat pumps that meet Energy Star program specifications.

Credit Amount is the sum of:

  • 10% of qualified energy efficient improvement costs (insulation, doors, and certain metal roofs)
  • 10% of the cost of qualifying windows, up to a maximum credit of $200
  • 100% of residential energy property expenses, subject to dollar limitations: $150 for a furnace or hot water boiler, $50 for a circulating fan, and $300 for other property.

Note: Unlike other credits, this provision has a $500 maximum lifetime limit.

Effective Date: 2006 and 2007.

Fuels from Non-conventional Sources

Description: The Energy Act of 2005 created a new credit for qualifying production of fuels from agricultural biomass (plant material).

Credit Amount:

  • This credit is $1.00 per gallon of agri-biodiesel fuel produced.
  • New $.10 per gallon credit for small producers of agri-biodiesel fuels. The credit becomes part of the general business credit, which allows a 1-year carry back and 20-year carry forward previously not allowed.

Effective Date: 2006-2008.

Renewable Energy Resources Credit

Description: The credit for electricity produced from renewable energy resources is expanded to include Indian coal facilities and qualified hydropower facilities. The new law also extends certain provisions of the existing renewable energy credit.

Credit Amount:

  • The credit for Indian coal is $1.50 per ton through 2009 and $2.00 per ton after 2009.
  • The credit for hydropower production is $.95 per kilowatt hour of electricity produced.

Effective Date: The credit is effective for qualified facilities placed in service on or after August 8, 2005 and before Jan. 1, 2008. The credit can be claimed by the facility for 10 years thereafter (7 years for Indian coal facilities).

New Home Energy Efficiency

Description: General business credit for contractors who construct new energy-efficient homes in the United States. Eligible homes include single family dwellings, houseboats, house trailers, and apartment buildings. The amount of the available credit depends on the projected reduction in heating and cooling costs over comparable dwellings.

Credit Amount:

  • Homes with a projected 30% cost savings: $1,000
  • Homes with a projected 50% cost savings: $2,000

Effective Date: 2006 and 2007.

Solar Investment

Description: Business credit for installation of qualifying solar energy property including fiber optic equipment that uses solar energy to light the interior of a building and solar property that is used to heat or cool a building or provide hot water. Equipment used on swimming pools does not qualify.

Credit Amount: 30% of qualifying costs.

Effective Date: 2006 and 2007

Energy Efficient Appliances

Description: A business credit for the production of energy efficient clothes washers, refrigerators, dishwashers. The credit does not apply to the purchase of these appliances, but the manufacturer may pass the credit on to the consumer in the form of a reduced price.

Credit Amount:

  • Refrigerators: $75 - $125
  • Dishwashers: Up to $100
  • Clothes washers: $100

Effective Date: Appliances manufactured in 2006 and 2007

Fuel Cells and Microturbine Power Plants

Description: This nonrefundable credit applies to qualified equipment installed on commercial buildings, including rental property. A fuel cell uses electromechanical means to convert fuel into electricity. A microturbine converts fuel into electricity and thermal energy.

Credit Amount:

  • Microturbine power plants: 10% of expenses up to a maximum of $200 per kilowatt of capacity
  • Fuel cell property: 30% of expenses up to a maximum credit of $500 per half kilowatt of capacity

Effective Date: 2006 and 2007. Property must be placed in service after 2005.

Energy Efficient Commercial Building Property

Description: Unlike the other provisions, this benefit comes in the form of a deduction for amounts paid or incurred for energy efficient building property installed in connection with the construction of commercial, depreciable property in the United States. Energy efficiency requirements include reduced cost for interior lighting, heating, cooling, hot water, and ventilation systems. The installation must be part of a certified plan.

Credit Amount: The deduction is limited to $1.80 per square foot of affected property. A partial deduction may apply in some cases.

Effective Date: Property placed in service in 2006 and 2007.

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American Jobs Creation Act of 2004 (HR4520)

Individual Provisions

ISOs and ESPPs. FICA (including Medicare tax), Railroad Retirement taxes and FUTA taxes will not be imposed on compensation resulting from the exercise of incentive stock options (ISOs) and employee stock purchase plan options (ESPPs). In addition, federal income tax withholding is not required on a disqualifying disposition of stock acquired in the exercise of a statutory stock option. This provision is effective for options exercised after the date of enactment.

State and Local Sales Tax Deduction: Taxpayers may elect to take an itemized deduction for State and local general sales taxes instead of deducting State and local income taxes. If taxpayers elect to deduct sales taxes, they may accumulate receipts and deduct their actual sales taxes paid or may use tables created by the IRS. If they choose to use the tables they will also get to deduct actual sales taxes paid on certain items such as cars and boats because sales taxes for those items will not be reflected in the IRS tables. The deduction is effective for 2004 and 2005.

Attorneys' Fees and Costs Incurred With Respect to Civil Rights Litigation: Taxpayers who incur legal fees and costs in connection with actions involving discrimination and other civil rights violations may take an above-the-line deduction for such fees and costs. The deduction cannot exceed the amount of the judgment or settlement includible in the taxpayer's income for the year. The deduction is effective for fees and costs paid after the date of enactment with respect to any judgment or settlement occurring after the date of enactment.

Rural Mail Carriers: Rural mail carriers that use their personal vehicles for mail delivery may now deduct vehicle expenses in full. (Under prior law, the deduction is limited to the amount of the reimbursement received.) Effective for taxable years beginning after December 31, 2003.

Business Energy Credits and AMT
The following credits are allowed against AMT:

  • The alcohol fuels credit (effective beginning in 2005).
  • The credit for electricity produced from renewable resources (applies to facilities placed in service after the date of enactment and only for the first four years of production).

Exclusion on Sale of Principal Residence: The $250,000 ($500,000 MFJ) exclusion does not apply if the principal residence was acquired in a like-kind exchange in which any gain was not recognized within five years prior to the sale. Effective for sales or exchanges after the date of enactment.

Exclusion for Payments Under National Health Services Corps Loan Repayment Program: Payments made to program participants to repay their outstanding student loans are no longer included in the participant's taxable income. In addition, the payments are no longer subject to employment tax. Effective for amounts received in taxable years beginning after December 31, 2003.

Suspension of Interest on Potential Underpayments: Taxpayers may deposit cash with the IRS in order to avoid the accrual of underpayment interest while the taxpayer and the IRS resolve a dispute as to liability. It appears this provision is codifying Revenue Procedure 84-58 regarding cash bonds. Effective for deposits made after the date of enactment.

Installment Agreements: Specifically provides that the IRS may enter into installment agreements that provide for partial payment of the total amount owed over the period of the agreement. The IRS must review these agreements every two years to determine whether the financial condition of the taxpayer has significantly changed so as to warrant an increase in the amount of the payments being made. Effective for installment agreements entered into on or after the date of enactment.

Charitable Contribution Provisions:

  • Patents and Other Intellectual Property-- The charitable deduction in the year of contribution is limited to the lesser of the taxpayer's basis in the contributed property or its fair market value. In addition, the taxpayer may take an additional charitable deduction, for up to 12 years, based on a percentage of the income received by the charity with respect to the property. The additional deduction is 100% of income for the first two years and then decreases by 10% per year until it reaches 10% for years eleven and twelve. The taxpayer must obtain written substantiation from the charity of the amount of income and the charity must file an annual information return reporting the income. Effective for contributions made after June 3, 2004.
  • Noncash Charitable Contributions-- All donors, including corporations, must obtain a qualified appraisal of contributed property (other than inventory, publicly traded securities, or certain vehicles) if the amount of the claimed deduction is greater than $5,000. In addition, all donors are required to attach a qualified appraisal to their tax return if the amount of the claimed deduction is greater than $500,000. Effective for contributions made after June 3, 2004.
  • Motor Vehicles, Boats and Airplanes-- The reporting requirements for donations of cars, boats, and planes are increased if the deduction is greater than $500. In addition, if the charity sells the vehicle, within 30 days of the sale the charity must give the donor a written acknowledgment that states how much it received from the sale. The allowed deduction is limited to the proceeds from the sale. If the vehicle is not sold, the charity must give the donor an acknowledgment within 30 days of the contribution and indicate in the acknowledgment its intended use of the vehicle. The taxpayer must attach the acknowledgment to his or her tax return. Effective for contributions made after December 31, 2004.

IRS User Fees: IRS user fees are extended for ruling requests, etc. made through September 30, 2014.

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Working Families Tax Relief Act of 2004 (HR1308)

The Working Families Tax Relief Act of 2004 extends several provisions that expired at the end of 2003 or were scheduled to expire at the end of 2004. It also contains some new provisions and technical corrections. Here is a summary of the new and extended provisions.

PROVISIONS RETROACTIVE TO JAN. 1, 2004
AMT through 2005, the following personal nonrefundable credits will continue to be allowed against AMT as well as regular tax. These credits are:

  • Child and Dependent Care Credit
  • Credit for the Elderly and Permanently and Totally Disabled
  • Mortgage Interest Credit
  • Hope and Lifetime Learning Credits

Child Tax Credit-- Beginning in 2004, earned income for purposes of the child tax credit includes excludable combat pay. In addition, the refundable portion of the credit is determined by using 15% of earned income rather than 10%. This provision applies to families with earned incomes in excess of $11,000 (2004). The additional child tax credit is the lower of (1) the unused child tax credit or (2) (taxable earned income - $11,000) x 15%. This will increase the child tax credit for many low-income families.

Earned Income Credit-- For 2004 and 2005, military personnel who receive excludable combat may elect to include excludable combat as earned income for EITC purposes. Individuals whose EITC would be increased should make the election. We expect guidance regarding how the election is to be made.

Archer Medical Savings Accounts-- MSAs may continue to be established through 2005, or until the statutory limit for the number of accounts is met, whichever is earlier. The trustee report required to be made on August 1, 2004, shall be treated as timely if made before the close of the 90-day period beginning on the date of the enactment of this Act.

Educator Expenses-- An above-the-line deduction of up to $250 is allowed for qualifying classroom expenses. The deduction may be claimed by full-time primary and secondary education teachers and certain other school personnel. Extended through 2005.

Work Opportunity Credit-- Up to 40% (25% in certain circumstances) credit of first-year wages, up to $6,000 of wages per eligible employee. Up to $3,000 of qualifying summer employment is eligible for the credit. The New York Liberty Zone Work Opportunity Credit is also extended. These credits were extended through 2005.

Welfare-To-Work Credit-- The welfare-to-work credit allowed to employers who hire qualifying welfare recipients. Employers may claim a 35% credit of the first $10,000 of eligible wages in the first year of employment plus a 50% credit for the first $10,000 of eligible wages in the second year of employment, extended through 2005.

Research Credit-- The business credit for research expenses is extended through 2005. The credit was scheduled to expire June 30, 2004.

Percentage Depletion-- The temporary suspension of the income limitation for claiming percentage depletion is extended through 2005.
Electric Vehicle Credit-- The scheduled phase out of the credit is postponed until 2006. Under prior law, 75% of the credit would have been allowed in 2004 (50% in 2005, 25% in 2006, and 0% there after).

Deduction for Clean-Fuel Vehicles-- The scheduled phase out of the deduction is postponed until 2006. Under prior law, 75% of the credit would have been allowed in 2004 (50% in 2005, 25% in 2006, and 0% there after).

Charitable Contributions of Computer Technology and Equipment Used For Educational Purposes-- For qualifying contributions (IRC section 170(e)(6)), this provision limits the reduction of the allowed contribution based on other-than-long-term capital gain, extended through 2005.

Environmental Remediation Costs-- Qualifying environmental cleanup costs (IRC section 198) may continue to be expensed, extended through 2005.

District of Columbia--

  • First-Time Homebuyer Credit - The D.C. first-time homebuyers credit is the lesser of (1) $5,000 or (2) the purchase price of the residence. The credit is phased out based on modified adjusted gross income. This credit is extended through 2005.
  • D.C. Enterprise Zone - D.C. Enterprise Zone benefits are extended including, but not limited to, the D.C. wage credit and the $20,000 additional section 179 expense allowance.
  • Tax-Exempt Economic Development Bonds - These bonds can continue to be issued through 2005.
  • Zero Percent Capital Gains Rate - This provision applies to qualifying DC Zone business stock, partnership interest, or business property held longer than five years. Qualifying property must be acquired prior to January 1, 2006. Qualified gains must be incurred prior to January 1, 2010.

Credit for Energy Produced from Renewable Resources-- This credit is extended through 2005.

EXTENSIONS FOR 2005 AND LATER YEARS

AMT-- The expanded AMT exemption amounts that were due to expire in 2004 are extended for one year, through 2005.

Marriage Penalty Relief-- The 15% rate bracket for MFJ remains at twice that of single filers through 2010. The standard deduction for MFJ remains twice the single standard deduction through 2010.

10% Rate Bracket Expansion-- The 10% rate bracket remains at $7,000 for Single and MFS filers and $14,000 for MFJ filers through 2010. The amount will be adjusted for inflation.

Child Tax Credit-- The child tax credit remains $1,000 per child through 2010.

Indian Employment Tax Credit-- This credit is extended through 2005.

Accelerated Depreciation for Business Property on Indian Reservation-- This provision is extended through 2005.

UNIFORM DEFINITION OF CHILD (effective 2005)
The new law creates a uniform definition of qualifying child for the tax benefits that relate to children. Under the new law, a qualifying child must meet only three tests, relationship, residence, and age. These rules are summarized below.

  • Relationship-- The child must be the taxpayer's son, daughter, stepchild, sibling, stepsibling, or a descendant of such individuals. Foster children placed with the taxpayer by authorized placement agencies would satisfy the relationship test. If the child is the taxpayer's sibling or stepsibling or a descendant of any such individual, the taxpayer must care for the child as if the child were his or her own child.
  • Residence-- The child must live with the taxpayer in the same principal place of abode for over half the year. Military personnel on extended active duty outside the United States would be considered to be residing in the United States. As under current law, the taxpayer and child are considered to live together even if one or both are temporarily absent due to special circumstances such as illness, education, business, vacation, or military service.
  • Age-- The child must be under the age of 19, a full-time student if over age 18 and under age 24, or totally and permanently disabled. However, as under current law, qualifying children (who are not disabled) must be under age 13 for purposes of the child and dependent care tax credit and under 17 (whether or not disabled) to qualify for the child tax credit.

Tie-breaker rule similar to the current EITC tie-breaker applies if more than one qualifying taxpayer claims a benefit for the same child. The new rule affects the following tax benefits:

  • The dependency exemption.
  • The child tax credit.
  • The earned income credit.
  • The dependent care credit.
  • Head of household filing status.

Notes: The prior-law rules are generally retained for individuals to whom the uniform definition does not apply. If a child files a joint return the uniform definition rules do not apply. Prior-law rules may be used instead.

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Military Family Tax Relief Act of 2003
The Military Family Tax Relief Act of 2003 was signed into law on Veteran's Day, November 11, 2003. This new law provides tax breaks to active-duty military personnel, reservists, and certain civilian employees of the Armed Forces. Special tax relief for Space Shuttle astronauts who die in the line of duty was also included. Several of the provisions are retroactive to earlier tax years.

Note: Other provisions were included in the bill as follows. These provisions are not discussed in this article:

  • Expansion of the definition of organizations qualifying for exempt status as veterans' organizations.
  • Suspension of the tax-exempt status of terrorist organizations.
  • Extension of customs user fees.

Capital Gain Exclusion for Home Sale
Effective for sales occurring after May 6, 1997
Military personnel may make an election to suspend the running of the five-year period during the time the taxpayer or his or spouse is serving on qualified official extended duty. The period cannot be extended for more than ten years.
Qualified official extended active duty means any extended active duty at least 50 miles from the residence or while living in Government-ordered Government quarters. The call or order of duty must be in excess of 90 days or indefinite in length.

Example: Tom and Susan Delong purchased their home in January 18, 1996. On March 6, 1998, Tom was assigned to extended active duty in Germany, where he lives with his wife in base housing. The couple rented their home until November 4, 2002 when it was sold. Prior to the law change, the DeLongs could not have met the two-year use test because they've been out of the home more than three years. Under the new law, they may ignore the 3 years and seven months that they were in Germany. Because they meet the two-year use test for the period that is counted, they may exclude the gain on the sale of their home under the usual rules.

Making the election--More information on how the election is made is expected soon. One important note is that the election may be in effect for only one property at a time. The election may be revoked at any time.

Important: Returns for closed years, including previously audited returns, may be amended within one year of the date of enactment.

Tax-Free Treatment of Death Gratuity Benefits
Effective date: September 11, 2001
Under current law, survivors of members of the military receive a $6,000 death gratuity payment, but only half of it is tax-free. Under the new law, the amount of such payments received for deaths occurring after September 10, 2001 are increased to $12,000 and the benefit is fully exempt from tax.

Important: Because the new law is retroactive to 2001 and 2002, families who received payments for deaths that occurred after Sept. 10, 2001 but before 2003 should amend their tax returns to remove the $3,000 of taxable income that was included on their returns. The reduced adjusted gross income (AGI) and tax liability may affect other items on the return as well.

Tax-Free Treatment of "HAP" Payments
Effective for open years (2000 forward)
Amounts received under the Homeowners' Assistance Program may be a tax-free fringe. HAP payments are made to compensate military personnel and certain civilian employees for a drop in home values resulting from military base closures or realignments.
The bill provides that these payments are tax-free to the extent the amount does not to exceed:

  • The difference between 95% of the fair market value of their property prior to public announcement of intention to close all or part of the military base or installation and the fair market value of such property (as such value is so determined) at the time of the sale, or
  • The purchase price for their property, not to exceed 90% of the prior fair market value or the amount of the outstanding mortgages.

Payments to reimburse the homeowner for the costs of selling the property are not excludable under the new law.

Important: 2000 tax year returns affected by this change must be amended by April 15, 2004.

Extension of Combat Zone Filing Rules to Contigency Operations
Effective for open years (2000 forward)
Prior to this law change, several deadlines such as those for filing tax returns and making tax payments were extended for certain individuals serving in a combat zone during a period of combatant activities. The new law extends the provision to such individuals serving:

  • outside the United States away from his or her permanent duty station,
  • while participating in a contingency operation.

A contingency operation is defined as "military operations designated by the Secretary of Defense in which personnel are or may become involved in military actions during a war or national emergency declared by the President or Congress or which become a contingency operation by operation of law."
This change primarily affects penalties and interest imposed on late returns and late payments. Taxpayers affected by this change may amend their tax returns to request recalculation and abatement of penalties and interest. Tax year 2000 returns must be amended by April 15, 2004.

Overnight Travel Expenses of Military Reservists
Effective date: January 1, 2003
For expenses incurred after 2002, an above-the-line deduction is allowed for non-reimbursable travel expenses for military reservists who serve more than 100 miles away from home and stay overnight. Expenses cannot exceed the rate for travel expenses, including per diem in lieu of subsistence, for government employees.

Distributions from QTPs and Coverdell ESAs
Effective date: January 1, 2003
Appointments to a military academy are treated like scholarships for purposes of the exception to the 10-percent penalty related to QTP and ESA distributions. Under the provision, distributions from a QTP or ESA are not subject to penalty to the extent the distribution does not exceed the cost of attending the academy.

Dependent Care Benefits
Effective date: January 1, 2003
The new law specifically provides that dependent care assistance provided under a military dependent care assistance program is a tax-free benefit. This provision is effective for tax years after 2002.

Tax Relief for Space Shuttle Heroes
Effective for deaths occurring after December 31, 2002
The tax forgiveness provisions that were enacted for individuals killed in terrorist attacks is extended to any astronaut who dies after December 31, 2002 when the death occurs in the line of duty.
Under the law, the tax imposed in the year of death of a qualifying individual is forgiven in full. A minimum $10,000 benefit is allowed. Estate tax relief also applies.

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State Tax Law Changes Related to Military Personnel

Virginia: Tax Deferrals for National Guard Members
On March 20, 2003, the governor signed into law legislation that extends tax deferral and leave time protection benefits to certain National Guard members.

Tax Deferral
National Guard personnel who are unable to pay their state taxes because of their military service may apply for deferral of those taxes. The individual must prove both the inability to pay to the tax and that the inability to pay is a result of military service.
Federalized National Guard members qualify for this deferral under the Federal Soldier's and Sailor's Civil Relief Act. Virginia National Guard members who are called to active duty for more than 30 days but who are serving on active duty for the state of Virginia.

State employee leave time
Full-time Virginia state employees serving in the National Guard are allowed to carry forward their leave time without limitation.