As you leave the military, you may soon realize another wound to your budget: the tax bite.
“As you look at your next job and the salaries they’re going to offer you, you have to take into consideration the fact that all pay and your property is subject to taxes,” said Army Lt. Col. Samuel Kan, tax counsel for the DoD Office of Legal Policy and Military Compensation’s Armed Forces Tax Council. “That’s a very significant hit.”
Where to look for a tax bite and other ways to protect your finances after the military:
New state of residence. Whether you retire or separate before retirement, you are no longer protected by the Servicemembers Civil Relief Act, which allows service members to pay taxes based on the state where they claim legal residence. In many cases, those legal domiciles are states that have no state income tax. Where you start working after leaving the military is now your state of residence.
Certain pay was never taxed.
The fact that the Basic Allowance for Housing is not taxable is significant, Kan said. Other nontaxable benefits, such as the Basic Allowance for Subsistence and combat zone pay, also disappear after the military.
“Whatever that civilian company says you will get is taxable,” Kan said. “So $100,000 in civilian pay is not the same as $100,000 in the military” — the pay may be 75 percent of what you thought you’d be getting, because of the tax nip.
Some states will tax your car.
Personal property taxes can be a surprise. While you were on active duty, you may not have had to pay personal property taxes on that expensive truck because you weren’t a resident of the state. You may have paid only a licensing fee. But now that you’re a civilian, you may have to pay hundreds of dollars in annual personal property taxes. Katie Savant said she and her husband, a Marine veteran, pay more in taxes in California than in their previous domicile state of Colorado. They pay about $100 to $150 more a year per car now, she said.
Non-domicile states may try to collect back taxes.
While on active duty, make sure to maintain strong ties with your domicile state by voting, keeping licenses current, etc. It’s possible, Kan said, that a state could attempt to collect back taxes from a transitioning service member — such as if a service member stays in an area after retirement and doesn’t return to his state of legal residence. “There’s some risk if you fail to maintain ties with the past state of residence,” Kan said. “It’s important to keep those ties.”
Some states tax military retirement pay — others don’t.
The Navy publishes a state tax guide eachyear with information about states that don’t tax military retirement, but those laws keep changing. For example, the South Carolina legislature enacted a law this summer that allows individuals under age 65 who receive military retirement income to deduct up to $17,500 of earned income, Kan said; for those ages 65 and over, the deduction is up to $30,000. For both of these groups, the deductions will be gradually phased in, starting in 2016.
Spouse’s domicile may be tied to service member’s.
Many of these issues related to income taxes and property taxes also apply to spouses, who under the SCRA are allowed to claim a state of domicile based on certain restrictions and requirements. But if the military member is no longer covered under the SCRA, neither is the spouse.
Individual situations tend to crop up.
Savant’s husband left the Marine Corps after 10 years in August 2014 and had federal student loans forgiven because he had a 100 percent disability rating. But the couple soon found there was a tax penalty: They had to pay taxes on the amount that was forgiven because it was treated as income. “It’s a burden on the family,” she said.
RETIREMENT RISKS
Survivor Benefit Plan.
Before retirement, when considering the Survivor Benefit Plan as a means of providing income for your survivors, look up the tax implications. The monthly premium for SBP is pre-tax out of your retirement pay. SBP can be a good tool, and it may be cheaper than you think, Kan said, because it reduces your taxable military retirement income.
VA disability pay.
Taking VA disability pay may seem like a good idea on the surface because it’s not taxable and you lower your military retirement pay by that amount. But if you’re waiving military retirement income to get that disability pay, that could be an issue if you’re divorced. If your court decree says you have to pay a certain percentage of your retirement income to your ex-spouse, and that retirement income is reduced by VA disability pay, you still must make sure to comply with the court order.
Thrift Savings Plan.
When preparing for retirement or separation, consider what you’ll do with the money you have invested in your Thrift Savings Plan and other retirement accounts. You don’t have to move it. Kan said considerations include whether an employer plan or other investment vehicle has fees, or its investment choices may not be as good. The TSP has low fees and good choices, he said. If you decide to move the money, ”just do it in a well-thought-out way and for logical reasons,” Kan said. But whatever you do, don’t just withdraw the money — there are significant tax penalties for withdrawing the money before age 59 ½. If you’re rolling it into another retirement account, make sure to work with the plan administrators or your financial expert to execute the rollover correctly.
MORE TO WATCH FOR
Affordable Care Act penalties.
If you’re separating from the military before retirement and don’t have minimum essential health care as defined in the Affordable Care Act, make sure you go to the health care exchange marketplace set up in your state, or you may be subject to penalties later.
CRSC vs CRDP.
Another consideration for separating service members is whether to apply for Combat Related Special Compensation or Current Receipt of Disability Pay. CRSC is not taxable; CRDP is taxable. But you can’t get them both. You have to compare the numbers to determine what’s best for your situation.
Taxing of disability severance pay.
Many service members’ disability severance pay is taxed, but it may be determined later that those payments shouldn’t have been taxed. One reason is that when separating, the service had no VA disability rating. But then later, when the service member receives that disability rating, and it’s determined the payments made previously were not taxable, then the service members should file an amended tax return to get that money back, Kan said.
