New Law Offers Tax Relief to Military Families
A new federal law may have a big impact on the state income tax bills of clients who are married to members of the Armed Services. Under the new law, these clients may be able to avoid paying income taxes in the state they are currently living in.
As a general rule, under most state laws, an individual who spends more than 180 to 183 days in a state is deemed to be a resident of that state. However, a member of the U.S. Armed Services (a “servicemember” in the language of the bill) does not automatically become a resident of the state where he or she is stationed.
Instead, the servicemember can remain a resident of his or her home state. This means the servicemember can continue to vote in the home state and be treated as a resident for other purposes.
Significantly, it also means that the servicemember’s military income is not subject to tax in the state where he or she is stationed. The Servicemembers Civil Relief Act specifically provides that compensation of a servicemember for military service shall not be deemed to be income for services performed or from sources within a tax jurisdiction of the United States if the servicemember is not a resident or domiciliary of the jurisdiction in which the servicemember is serving in compliance with military orders.
A new law that was enacted late last year extends similar relief to the spouses of servicemembers. The Military Spouses Civil Relief Act (P.L. 111-97) provides that a military spouse won’t be treated as having lost residence in one state or acquired residence in second state solely because he or she moves to the second state to accompany a servicemember spouse to a new duty station. Moreover, the law says that a military spouse’s earned income can’t be taxed by a state if the military spouse is living and working in the state solely to be with the servicemember spouse. Instead, the military spouse remains a resident of his or her original state for tax purposes.
Example: Jenna and Jordan, a married couple, are legal residents of Texas when Jordan enlists in the military and is sent to a duty station in California. Jenna moves with Jordan to California, where she finds a job with a software company. Result: Under the new law, Jenna’ s income from her job is not subject to tax in California. Instead, Jenna remains a “tax resident” of Texas (which, conveniently for Jenna, has no state income tax).
The new law applies retroactively to calendar year 2009. Consequently, military spouses whose 2009 earnings qualify for exemption from tax under the new law may be eligible for a refund.
REFUND OPPORTUNITY. According to the Federation of Tax Administrators, states plan to deal with 2009 withholdings by having eligible military spouses file a claim for refund directly with the state. So there will be no need for retroactive withholding adjustments. In fact, a number of states have issued preliminary guidance on how eligible spouses can claim refunds of 2009 withholdings. For example, California has indicated that eligible spouses can file for refunds using FTB Form 540NR, California Nonresident or Part-Year Resident Income Tax Return.
For 2010, eligible military spouses can claim exemption from income tax withholding in the duty station state. You can check with the state tax authorities and alert clients who are eligible military spouses to the proper procedures for submitting withholding exemption requests. Some states have indicated that eligible spouses should use existing exemption certificates, while other are revising their forms or developing special forms to be used for this purpose.
As a general rule, to qualify for the exemption, three basic conditions must be met:
The military spouse currently resides in a state different than the state of his or her domicile.
The military spouse resides in the state solely in order to live with the servicemember spouse.
The servicemember is present in the state in compliance with military orders.
However, the Federation of Tax Administrators makes it clear that each state will make its own interpretations of how and when the new law applies. The Federation says state regulations will differ on whether the military spouse and the servicemember have the same original domicile for the law to apply. For example, preliminary guidance from California indicates that a military spouse will be considered a nonresident for tax purposes if the servicemember and spouse have the same domicile outside California and the spouse is in California solely to be with the servicemember who is serving in compliance with military orders.
By contrast, both Maryland and New Jersey have indicated that a military spouse qualifies for exemption from state income tax if the servicemember is present in the state in compliance with military orders, the spouse is present in the state solely to be with the servicemember, and the spouse maintains a domicile in another state.
Key Point: The new law does not create an overall exemption from all state income taxes for military spouses. The exemption from tax by a duty station state applies only to wages or income from services performed in the state. It does not apply to non-service income, such as income from rental property. Moreover, a military spouse remains liable for income tax (if applicable) in his or her home state — including tax on income earned in the duty station state.
Under the Servicemembers Civil Relief Act, a servicemember declares a “legal residence” for purposes of withholding state income taxes from military pay. However, it remains to be seen whether states will require a residence declaration from military spouses or will require reporting of earnings to the military spouse’s state of residence. A task force of states is currently collaborating to establish common guidelines for implementing the new law.
Reach Out to Clients
So you can reach out to military spouses explaining the refund potential for 2009 and the withholding exemption opportunity for 2010, we have prepared a client letter that you can adapt as needed.
Quick Tax Relief for Clients with Net Operating Losses
For your individual and corporate business clients with net operating losses (NOLs), a new tax law offers potential relief.
The Worker, Homeownership, and Business Assistance Act of 2009 (P.L. 111-92) extends and expands a provision enacted early in 2009 that allowed certain small businesses to maximize their refunds from a 2008 net operating loss (NOL). The new law extends the refund provision to 2009 NOLs and expands its scope to cover almost all businesses.
Looking Up? Your clients who were ineligible for the earlier refund provision may now qualify for a quick cash infusion. Clients who were eligible for the earlier provision may now qualify for additional refunds.
A Little Background: Prior to the New Law
Generally speaking, an NOL (the excess of business deductions over gross income) may be carried back two years and carried forward 20 years to offset taxable income in those years. NOLs offset taxable income in the order of the taxable years to which the NOL may be carried.
How It Has Worked: A business can claim a refund for the carryback years by filing amended returns for those years (Form 1040X for individuals, Form 1120X for corporations). In the alternative, a business can file for a “quickie” refund by applying for a “tentative carryback adjustment” on Form 1045 (individual) or Form 1139 (corporation). The IRS must act fast on a claim for a tentative carryback adjustment within 90 days after the date it is filed. A tentative carryback adjustment claim must generally be filed by the end of the year following the year the NOL arises.
The American Recovery and Reinvestment Act of 2009 (ARRA), enacted by Congress last February (P.L. 111-5), contained a special relief provision for “eligible small businesses” (ESBs). At an ESB’s option, the NOL carryback period was increased to three, four, or five years. This provision, in turn, increased the chances that an NOL could be fully offset in carryback years (generating immediate refunds) instead of the ESB having to carry the NOL forward (and wait for tax reductions).
Example: An ESB elected a 5-year carryback period, the NOL would first be applied against the fifth year preceding the NOL year. If the NOL exceeded the fifth year’s taxable income, the excess would be carried forward to the fourth preceding year, and so on until it was exhausted. Only if the NOL exceeded the taxable incomes of the five preceding years would it be carried forward to years after the NOL year.
The special relief provision was available only for an NOL arising in a tax year ending in 2008, or, at the ESB’s election, a tax year starting in 2008. A business qualified as an ESB if it met a $15 million gross receipts test.
New Law Changes
The Worker, Homeownership, and Business Assistance Act generally allows all businesses, not just ESBs, to increase the carryback period to three, four or five years for an “applicable NOL” [IRC Sec. 172(b)(1)(H)]. An applicable NOL is a business’s NOL for a tax year beginning or ending in either 2008 or 2009. Any businesses can file a tentative carryback adjustment claim to get a quick refund from the new law change.
Note: The extended carryback period is not available to TARP recipients and certain other businesses receiving government assistance under the Emergency Economic Stabilization Act of 2008.
Also: The amount of an NOL that may be carried back to the fifth tax year preceding the loss year is limited to 50 percent of taxable income for the fifth year (computed without regard to the NOL).
Only One NOL: Choose Your Carryback Period
A business may generally elect an extended carryback period for only one NOL. So a calendar-year business client with an NOL in both 2008 and 2009 will have to choose the extended carryback period for the year that produces the better tax results. The NOL for the other year will be limited to the regular two-year carryback period. For fiscal-year clients, the choice will be from among the 2007-2008 year, the 2008-2009 year and the 2009-2010 year (assuming there are NOLs in all three years).
One Exception. An ESB that elected the extended carryback period under the original ARRA provision for an NOL from 2008 may choose a second extended carryback period under the new law for an NOL from 2009.
We have prepared a letter you can send to clients explaining this new tax relief provision; see below.
Electing the Extended Carryback Period
The IRS has announced the procedures to be followed to elect the extended carryback period [Rev. Proc. 2009-52, 2009-49 IRB] There are two ways to go about it.
Method 1
A client may make the extended carryback period election by attaching a statement to the original or amended return for the tax year in which the NOL arises. The statement must provide that the client is electing to apply IRC 172(b)(1)(H) under Rev. Proc. 2009-52, and that the client is not a TARP recipient nor, in 2008 or 2009, an affiliate of a TARP recipient. The statement must specify the length of the NOL carryback period the taxpayer elects (3, 4, or 5 years). The election statement must be filed with the return on or before the due date for filing the return for the client’s last tax year beginning in 2009.
A copy of the election statement must be attached to the client’s claim for tentative carryback adjustment (Form 1045 or Form 1139) or to the amended return applying the NOL to the carryback year. The due date for filing a claim for tentative carryback adjustment for the extended carryback period has been extended to the due date (including extensions) for filing the return for the client’s last tax year beginning in 2009.
Method 2
A client may elect the extended carryback period by attaching the statement specified in Method 1 directly to the tentative carryback adjustment claim or to the amended return for the carryback year. Again, the client must file the tentative carryback adjustment claim or amended return on or before the due date (including extensions) for filing the return for the taxpayer’s last tax year beginning in 2009.
Reach Out to Clients
So you can reach out to clients and prospective clients on these expanded benefits for NOL relief, we have prepared a client letter that you can adapt as needed.
How to select Tax Saving mutual Fund
Selecting the right tax-saving fund is easier said than done. PersonalFn has an article on the various tax saving Mutual Funds available and the factors that you should weigh in before signing the cheque. When it comes to investing to save tax, most of us are gurus already. After all, we have been investing to
save tax for many years and that too profitably. The Public Provident Fund (PPF) has been delivering
attractive post-tax returns. The equity heavy ULIP has done phenomenally well on the back of rising
markets. And then of course the tax-saving mutual funds have had a fantastic run in the last few years.
In short, the results have been brilliant. So why tinker with this ‘traditional’ approach of investing to save
tax?
In our earlier message to you we dealt with the PPF as a tool to save tax [Read]; now we focus on stock
market linked instruments which are so popular today.
A rising tide lifts all boats.
Here’s a fact – everyone who invested in a tax-saving mutual fund has made a lot of money over the last
few years. And this should not be surprising given that the Indian stock markets have recorded their
biggest gains in recent years.
No matter which mutual fund you invested in, irrespective of whether well-managed or not, as long as
the underlying asset was equities, you made money.
In rising markets, the more risk you take, the more returns you make In fact, the more risk you took, the
more returns you made. If you had more equity in your portfolio or if you invested in the more
aggressively managed mutual funds, you made more money as compared to someone with a more
moderate exposure.
And why not…the average return of all tax-saving funds over the last 3-Yrs (15 schemes) was an
unbelievable 45% CAGR!
In short, the going has been great! The returns are fantastic. But…
While you may actually deserve the credit for these gains in your portfolio, frankly, for most of you, most
of this success can be attributed almost entirely to the one-way surge in the stock markets.
Over the last few years you have taken unnecessary risk by first increasing your exposure to equities
beyond the desired level, and second, by investing in equity linked assets which are not-well managed
or are not suited to your risk appetite. If you persist with what you have been doing in the past, you may
be in for some unpleasant surprises.
Understand the risk of making a poor investment decision…
The range of returns from all tax-saving funds which have a 3-Yr track record is very wide from 67.6%
CAGR to 28.1% CAGR. So, even if you were in the 28% CAGR fund, you did well. Undeniably, there has
been a cost for having made a poor investment decision, but it has not pinched as much, since you still
made good money.
But the fact is that adjusted for risk, you definitely made a poor investment decision. In other words you
could have achieved a lot more, and too by investing sensibly, with your money!
This is not to say that the top-performing fund would have been the right choice. Quite to the contrary, if
you were advised by Personalfn, you would have actually given the top-performing fund a miss too… for
various reasons.
At present there are 23 tax-saving funds out there (and more on the way). Which fund suits you best, will
depend on your risk appetite, expectation of return and your overall asset allocation.
The future will reward smart fund managers
As stock markets turn more volatile, and the choice of funds increases, it will become pertinent to make
the right investment decision to start with. Going forward, the well-managed fund will outperform the
‘more-risk-you-take-the-more-return-you-make’ type of fund.
Understanding this is an important step to building a smart investment plan that is geared to saving tax.
Personalfn can help you save tax. Smartly. . We will guide you on the asset allocation that suits you
best; and we will also tell you which tax-saving funds are best for you.