This New Law Could Benefit Military Spouses Come Tax Time
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By Col. William P. Jensen, USAF (Ret), CFP® candidate
The Veterans Benefits and Transition Act of 2018 includes a provision that may have a significant financial benefit for certain military spouses. The act allows some spouses to receive a state income tax refund, and potentially eliminate or reduce their state tax bill going forward.
Signed into law on Dec. 31, 2018, the new law covers a variety of important benefits for active duty military members and their spouses. Of particular importance was a change to the way spouses can claim their state of residency. Previously, spouses had to change their residency every time their active duty military spouse was assigned to another state. Besides the time and expense of a new driver's license and voter registration, these spouses could lose state tax benefits depending on the location of their military spouse's new assignment.
[RELATED: FAQ: New Military Spouse Residency Rules]
The new law somewhat mirrors features of the Servicemembers Civil Relief Act (SCRA), which allows military personnel to maintain their legal residence when they are required to move due to a Permanent Change of Assignment. Specifically, SCRA allows military members to vote and pay taxes in only one state. This is especially helpful considering a civilian who moves to a different state typically must file a part-year-resident state income tax return with both the previous and current state of residence.
Not All State Are Created Equal When It Comes To Taxes
Because of SCRA, many military members eventually have the opportunity to claim their legal residence in a state that does not have state income taxes (i.e., when they are stationed in the state). Of note, there are currently nine states that do not assess a state income tax:
- New Hampshire*
- South Dakota
(* New Hampshire and Tennessee tax some dividends and interest. Tennessee is phasing out this levy; the last year for the so-called “Hall Tax” is 2021.)
Previously, a spouse of a military member could only enjoy this tax-free state while assigned in that state. Now, a spouse of a military member can elect to “join” their spouse in claiming one of the above states and enjoy the same tax-free benefit. The new law also allows the spouse to claim the same state as their military spouse even if they have never lived in that state.
Alternatively, some military members may belong to a state that has a lower state income tax rate than the spouse's current state of assignment. If so, the spouse can elect to claim the lower-rate state of their military spouse.
Read the Fine Print
It is important to note that state law can vary greatly when it comes to how military members and/or their spouses are treated for tax purposes when they are assigned outside their legal state of residence. For example, Pennsylvania does not assess state income tax on active duty military members assigned outside of the state, but that exclusion does not apply to the spouse. By contrast, California does not assess state income tax for either the military member or their spouse assigned outside the state. So, again, a careful state-by-state assessment is necessary for each spouse.
[RELATED: MOAA's State Report Card and Tax Guide]
This act was signed into law so recently that many states are still establishing processes, which will vary from state to state.
As a preliminary step, a spouse who has decided to choose his or her servicemember's state of residence should file state tax returns in that state. Returns for refunds also would be filed in the state where he or she paid taxes in 2018, if different. That could equate to hundreds or thousands of dollars in refunded state taxes. Keep accurate records for inclusion in both the 2018 and 2019 federal tax returns.
As an immediate benefit, a spouse should also notify their employer about their change in state of legal residence and decrease or discontinue the state income tax withholding.
The Internal Revenue Service started accepting tax returns Jan. 28, and states generally start accepting returns around the same time.
Consult an Expert
While reviewing your specific situation, and ways you could take advantage of this new legislation, be sure to consult with a Tax Expert (Enrolled Agent/CPA), or Certified Financial Planner (CFP®) that is aware of these changes and has experience working directly with military families.
Col. William P. Jensen, USAF (Ret), is a Certified Financial Planner (Candidate) with Hughes Financial Services, LLC. in Herndon, Va. He is a Life Member of MOAA.