CONGRESSIONAL AUDITORS have confirmed low-income military families’ complaints that combat-zone tax breaks actually are lowering their family incomes. Strange as that seems, in 2003 it happened to between 5,000 and 10,000 military personnel, writes the General Accounting Office (GAO) in a May 7 letter report to the Senate Finance Committee. The affected servicemembers, most of whom served in Iraq and Afghanistan, suffered income losses of up to $4,500 because combat-tax exclusions lowered taxable incomes enough to disqualify them for more valuable tax credits such as Earned Income Tax Credits (EITC) and the Additional Child Tax Credit.

Victims of the net loss in tax benefits typically are lower-grade enlisted or junior officers who spent seven months or more in combat zones during the tax year, are married with children, and have little or no other income. But even some members with working spouses saw tax benefits fall during wartime service, the GAO says. Their numbers are harder to estimate, the auditors said, and likely don’t exceed several thousand total personnel.

The report (GAO-04-721R) to Sens. Charles Grassley (R-Iowa), committee chairman, and Max Baucus (D-Mont.), its ranking Democrat, said DoD is aware of the “unintended consequences’’ from combining tax breaks and is drafting a legislative solution.

In an interview, Charles Abell, principal deputy undersecretary of defense for Personnel and Readiness, said DoD did float a proposal to address the problem this spring, but it failed to clear the White House’s Office of Management and Budget. Treasury officials said it would lower tax revenues and therefore opposed it.

“We will continue to work [the issue] and try again next year,” says Abell. The committee requested the report, “Active Duty Compensation and Its Tax Treatment,’’ to confirm the quirky effects of combat-zone tax breaks and assess military compensation overall and to detail for senators what opportunities exist for “wealth building’’ by servicemembers. The report noted a recent Congressional Budget Office finding that the government spends an average $56,000 a year (in 2002 dollars) on each active duty member to provide benefits.

The military tax advantages typically jump when a servicemember is assigned to a combat zone, where spending just one day results in tax exclusion for the servicemembers’ earned income for the month. The exclusion is unlimited for enlisted servicemembers and capped for officers—in 2003, that ceiling was $5,958 a month.

But the GAO said “complex interactions’’ of the combat zone exclusion with federal programs such as EITC and the Additional Child Tax Credit leave some low-income service families worse off financially for members having gone to war. In 2003, more than 21 million American workers qualified for refundable tax credits under EITC. The credits can wipe out their tax liability and result in thousands of extra government payments. And over certain income ranges, the amount of EITC earned increases with a worker’s taxable income.

When low-income servicemembers are assigned to combat zones, the resulting tax exclusions can lower taxable income and reduce or eliminate more valuable tax credits for military families.

“These members actually suffer a net loss in tax benefits because they receive no offsetting advantage from the [combat-zone] tax exclusion,” says the GAO. Of roughly 430,000 servicemembers who served in a combat zone in 2003, the GAO said, between 5,000 and 10,000 members in “one-earner households’’ suffered a tax benefits loss, the size of which varies by circumstances. But this past year it was as high as $4,500 for some enlisted servicemembers and as high as $3,200 for certain officers.

The mix of combat tax exclusions and tax credits also brings positive unintended consequences, the GAO says. Combat tax exclusions can leave some higher-income-earning servicemembers, up to the rank of colonel, with smaller taxable incomes that unexpectedly qualify them for tax credit refunds. Such windfalls also could be addressed with legislation, the GAO suggests.

Abell says DoD drafted proposed legislation to end this “inversion” by ignoring combat-zone tax exclusions for the purpose of calculating EITC or other special tax credits, so “my colonels don’t qualify and my privates do.” But this spring “the administration and Congress were having a fuss over extending tax cuts,” and given Treasury objections, the proposal was shelved. Defense officials will look for a way to offset any revenue loss, Abell says, and will push the issue again next year.

Tom Philpott is a freelance writer and syndicated news columnist. His column, "Military Update," appears in 48 daily newspapers throughout the United States and overseas.