April 15: The date alone is enough to cause a headache. Filing taxes is a task dreaded by most, but these six suggestions can help save your sanity — and your money.

By Phil Dyer, CFP, and Latayne C. Scott

State Sales Tax Deduction

You may choose to itemize either state income taxes or state sales taxes on Form 1040, Schedule A, for 2005. For those who itemize, state income taxes usually will provide the larger deduction. If you are filing taxes in a state that does not levy an income tax (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming), the sales tax deduction is a better choice. (Note: New Hampshire levies neither a state income tax nor a state sales tax).

“In either case, pay particular attention to large-ticket items you purchased in 2005, such as an automobile or boat,” advises California-based enrolled agent David A. Shaw, a federally licensed tax expert. “You will get to add the sales tax paid on the specific items to the amount allowed in the IRS tables for the sales tax deduction. In many states, due to the rising costs of these items, the sales tax deduction may be your best option when calculated correctly.”

Higher TSP Limits

If you are currently serving, your Thrift Savings Plan (TSP) contributions in 2005 were limited to 10 percent of base pay, plus 100 percent of special pays and bonuses, up to a maximum of $14,000. For those age 50 and older, a special catch-up provision is allowed for an additional $4,000 in contributions. In 2006, the percentage of salary limit is lifted for participants in the Uniformed Service TSP, and the contributory limit has been increased to $15,000 annually (plus an additional $5,000 catch-up provision for those age 50 and older). This will allow many junior and mid-grade officers to put more money into their TSPs, resulting in tax-deferred savings with pretax dollars while lowering the current tax bite.

Home Ownership Tax Relief

Under IRS rules, you must own and live in your principal residence for at least two years to fully exclude the gain on the sale of that principal residence from income taxes (up to $500,000 for married couples and up to $250,000 for singles). Shaw adds: “While both tests have to be met, they do not have to be met simultaneously. If you had to make a permanent change of station (PCS) and wished to sell your residence, you would qualify for the full or a reduced excludable gain. In many cases, the reduced excludable gain may be enough to exclude the gain on your current residence should you wish to sell.”

If you receive a PCS or extended temporary duties more than 50 miles from the residence, a special provision allows active duty military to suspend residency requirements on a principal residence for up to 10 years and still benefit from this powerful tax break. Shaw advises referring to IRS Publications 3 and 523.

TSP Lifestyle Funds

For those without the time or expertise to personally manage TSP investments, there is good news. Fund L, or Lifestyle Funds, became available in August 2005, offering a professionally designed mix of the other TSP funds (Funds C, F, G, I, and S).

You can choose a target year for retirement — L 2010, 2020, 2030, 2040 — or select the L Income option, and the Lifestyle Fund will provide automatic lower risk adjustments over time. Thus an aggressive investor just beginning active duty might choose the L 2030 Lifestyle Fund, while a more conservative investor who will retire in 2007 might opt for the L Income Lifestyle Fund.

Military Retired Pay Exemptions

Some states try to entice retirees by offering a tax break on military retired pay. The following states exempt military retired pay from state income taxes: Alabama, Alaska, Florida, Hawaii, Illinois, Kansas, Kentucky*, Louisiana, Massachusetts, Michigan, Mississippi*, Missouri*, Nevada, New Hampshire, New Jersey, New York, North Carolina*, Oregon*, Pennsylvania, South Dakota, Tennessee, Texas, Washington, Wisconsin, and Wyoming. Such exemptions can be worth an extra 3 percent to 8 percent in take-home pay. For military retirees who also are receiving a Social Security annuity, many states also make these payments fully or partially exempt from state taxes.

* These states have conditional exemptions.

Disability Pay and Concurrent Receipt

Recent MOAA-led legislative victories have authorized additional disability pay for combat-related injuries and partial restoration of military retired pay offset by VA disability awards. Unfortunately, there is some confusion between the two.

Combat-related special compensation (CRSC) is additional disability pay for qualified retirees with a 10 percent or greater VA rating because of combat or combat training. A servicemember must apply for CRSC. Once the award has been approved, it can be up to the current VA maximum disability payment for a 100 percent disabled veteran. CRSC is exempt from taxation at the federal (and often state) level.
 
Concurrent receipt and disability pay (CRDP) is automatic restoration of offset retired pay for retirees with a VA rating of 50 percent or higher who do not qualify for CRSC. CRDP is phased in over several years, with increasing annual payments. Because it is a restoration of retirement pay, it is fully taxable at the federal level. However, if someone is medically retired with nontaxable retirement, CRDP will not be taxed. Retirees who qualify for both CRSC and CRDP may make an annual election of which program to participate in, choosing the one with the greatest economic benefit and tax advantage. It can be confusing, so get expert advice when in doubt.

If you receive a backdated VA disability award, the Defense Finance and Accounting Service will not issue a corrected Form 1099-R, and you could end up overpaying your federal and state income taxes. The fix: File Form 1040X Amended Tax Return to adjust for any discrepancy created by a backdated VA award. Be sure to attach a copy of your VA award letter to the 1040X — and remember that you only have three years to amend prior returns.