Military Financial Advice - Army Times

New law gives troops a second chance to add to IRA

The Heroes Earned Retirement Opportunities Act, signed into law May 29, is significant for those who have spent or will spend much of the year deployed to an area eligible for the combat-zone tax exclusion.

Under prior law, if a service member had nontaxed combat pay and little or no taxable salary income, he was not eligible to make a regular or Roth IRA contribution.

Now, wages earned in a combat zone can be used to determine eligibility for contributing to a regular or Roth IRA, even though those wages are not subject to federal income tax. Best of all, this new law is retroactive to taxable years after 2003. So if you were deployed in a combat zone in 2004 or 2005 and couldn't contribute to an IRA under the old rules, you now have that chance.

In 2004, the maximum IRA contribution allowed was $3,000; it was $3,500 for those 50 and older. In 2005, the maximum was $4,000, with those 50 and older eligible to contribute up to $4,500.

Even though you have filed your taxes for those years, you can file an amended return (Form 1040X) and make your IRA contribution. If you made a partial contribution in those years, you can make a contribution up to the maximum amount for both you and your spouse.

Note that if your spouse had salary and/or self-employment income in 2004 and 2005, you were eligible in those years to make an IRA contribution even though your pay earned in the combat zone was not taxed.

Here are a few examples:

Example No. 1. Spc. Brad Jones was deployed to Iraq for all of 2004. His wife, Carrie, had a salary of $14,000. Under the old law, each could contribute up to $3,000 to an IRA.

In this example, Carrie contributed $3,000 to her IRA and Jones contributed $1,000 to his IRA.

Now, he can go back and contribute another $2,000 to his IRA for 2004. This extra contribution can be made any time before May 29, 2009, giving him almost three years. He will need to file an amended return for 2004.

Example No. 2. First Sgt. Smith is single and was stationed in Iraq for all of 2005. His combat-zone pay was not taxed, so he had zero taxable income and was not eligible to make an IRA contribution. He saved $10,000 of his salary while he was deployed.

Although he has already filed his 2005 tax return, he is now eligible to add $4,000 to his existing Roth IRA account for the 2005 tax year. Smith can make his 2005 IRA contribution from the $10,000 he banked while deployed and should talk with his tax preparer about filing an amended 2005 tax return.

He also had a regular IRA account totaling $8,000, which he converted to a Roth IRA account in 2005. Although this conversion was taxable, he paid no tax because the amount of the conversion was offset by the standard federal tax deduction and the personal exemption deduction. So his taxable income was zero.

Example No. 3. Sgt. Johnson is a single mother who was stationed in Afghanistan for all of 2004. She did have taxable income in 2004, however.

Right before she deployed, Johnson bought a lottery ticket. The ticket was a winner and paid $50,000 in 2004, which she put in a savings account for her retirement and her daughter's college education. All lottery payments are taxable income, so Johnson had a large tax bill. She is a resident of Texas, which does not have a state income tax, but her federal tax bill was $3,991.

With the rule change, Johnson can make the maximum regular IRA contribution of $3,000 for the 2004 tax year, which will reduce the tax she has paid by $450.

Example No. 4. Cpl. Jackson is single and was stationed in Afghanistan for all of 2004. He makes a Roth IRA contribution each year and saves additional money in a mutual fund. He bought a rental property in 2003, which pays him taxable income of $1,000 per month.

Although Jackson's combat pay in not taxable, he has $12,000 in rental income and $2,500 in taxable dividends from his mutual fund, for a total income of $14,500. His taxable income after subtracting the standard deduction and personal exemption was $6,550, and his total tax bill was $558.

Since he recently made a contribution of $3,000 to his Roth IRA account for 2004, he can take advantage of the retirement savings contribution credit when he files his amended return for that year.

His adjusted gross income is less than $15,000, so he will receive a tax credit of 50 percent of the first $2,000 contributed to an eligible retirement plan. His Roth IRA is eligible for the credit, as are the Thrift Savings Plan, regular IRAs and other retirement plans. Because he is eligible for a $1,000 maximum credit, and his tax bill before the Roth contribution was $558, he will be refunded the entire tax amount he paid in 2004.

To sum up, if you could not make an IRA contribution for 2004 or 2005 because your combat pay was not treated as eligible income for an IRA contribution, you can retroactively make a regular or Roth IRA contribution for those years.

You have until May 29, 2009, to do so, and you must file an amended return for those years. To claim tax refunds or credits, it is best to file your amended return as soon as possible after you have made your contribution.

Barbara H. Pietrowski is a licensed certified public accountant, certified financial planner and personal financial specialist. Her practice includes tax preparation, fee-only financial planning and investment management. E-mail her at barbarapietrowski@yahoo.com.