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Statements on Introduced Bills and Joint Resolutions - S. 2419

Location: Washington, DC


By Mr. PRYOR (for himself and Mr. BAUCUS):

S. 2419. A bill to amend the Internal Revenue Code of 1986 to provide additional relief for membes of the Armed Forces and their families; to the Committee on Finance.

Mr. PRYOR. Mr. President, our men and women serving in the military are the defenders of freedom and security around the world. The special role they play demands that they be "on call" to serve our Nation at points all over the globe.

The unique nature of their job has resulted in a unique and, I must say, very complex compensation package. The various types of compensation and benefits oftentimes create an especially difficult burden, especially when it comes to filing their tax return.

Through the years, Congress has periodically passed laws that recognize the special needs of our military and to lessen administrative burdens on them.

During consideration of such a bill last year, I approached the distinguished chairman of the Senate Finance Committee, Senator CHUCK GRASSLEY, and ranking member of that committee, Senator MAX BAUCUS, and asked them to join me in an effort to get a fresh look at the overall picture of how the Tax Code treats our military.

I was pleased when they agreed to join me in this work, and I was delighted to jointly request an expedited study by the GAO. It has been an honor to work with them and their staffs throughout this process, and I believe our work will produce good things for our military.

Yesterday, GAO released a report as a result of our request. The report raises many interesting findings, but there is one especially important issue that demands our immediate attention. Mr. President, I want to discuss the problem identified by GAO, and then I will introduce a bill to correct the inequity that has been documented.

The problem identified by GAO is the result of complex interactions between the combat zone exclusion under section 112 of the Internal Revenue Code and the earned-income tax credit and the child tax credit.

Under the combat pay exclusion, a very important benefit provided by Congress, military pay earned-including basic pay, bonuses, special pay and allowances-is excluded from taxable income while members of the military are serving in a designated combat zone.

That is right, Uncle Sam doesn't impose taxes on military pay for those serving our country in combat zones-and rightfully so.
However, income excluded under the combat pay provision is also excluded from income for the purpose of computing the earned-income tax credit and the child care credit.

As a result of this, thousands of men and women serving in combat, in places such as Iraq, Afghanistan, and other places around the globe, will see a reduction or elimination of their earned-income tax credit or the child tax credit and, in effect, because of how these interact, will lose money. In other words, the Tax Code has the impact of penalizing them because they are serving in combat zones. That is the opposite effect intended by Congress.

The GAO report characterizes this result as an "unintended consequence." I call it a wrong, and I urge my colleagues to join me in fixing this glitch as soon as possible.

The urgency of this situation is highlighted especially when you focus on those of our troops which this affects.

We are talking about troops who tend to be in combat for more than 6 months, who are not making much money, who have families to provide for and have little or no savings or little or no spouse income.

I am going to repeat that. We are talking about a clear wrong in the Tax Code that takes money away from men and women serving this Nation heroically and in dangerous places such as Iraq and Afghanistan.

The GAO analysis suggests the amount of the tax benefit loss enlisted personnel could face is up to $4,500 and $3,200 for officers. This is real money, make-or-break money, to many of these families who are already under an enormous amount of stress. This money will make a real difference and we need to get about the business of fixing this problem as soon as possible.

To correct the unfairness of current law, I am introducing the Tax Relief for Americans in Combat Act. The bill allows men and women in uniform serving in combat to include combat pay for the purpose of calculating their earned income tax credit and their child tax credit benefits. In other words, they will be able to continue receiving their rightful combat pay exclusions while having the ability to take full advantage of other tax credits. I urge my colleagues to join me in this effort. It will make a real difference for thousands of military families across the Nation.

I thank Liz Liebschultz and Christy Mistr of the Finance Committee staff for their advice and counsel in helping me sort through this matter in generating this GAO report. They did the work in drafting the provisions of this bill to make sure these provisions could be adopted by the Senate as soon as possible.

Also I want to recognize the GAO team which put this report together, because they did a lot of work on this: Jim White, Derek Stewart, Lori Atkinson, Jennifer Gravelle, John Pendleton, Sonja Ware, and James Wozny. They did a great job in preparing this report and I appreciate their hard work.

While we found this tax breakdown in the GAO report, there is also a lot of good news in the report regarding the compensation of our military personnel and I hope my colleagues will take time to review what the GAO says in all the information provided.

During a time of war, I do not want to lose sight that the Senate Armed Services Committee chairman, Senator JOHN WARNER of Virginia, and the ranking member, Senator CARL LEVIN of Michigan, are taking care of our troops financially.

One thing we talked about in the Armed Services Committee is recruiting and retention. Are we going to be able to meet those two objectives for our military? Well, I think today with this bill we can send a clear message to our youth and our enlisted personnel that a military career is an amazing option, and the compensation is such that it can compete with the private sector.

There is a real problem with our Tax Code that needs to be fixed immediately and the good news is, it can be. The bill corrects a problem and lets our troops risking life and limb know while they are away fighting for us, fighting for freedom and democracy, we will be in the Senate fighting for them and fighting for their families.

I urge my colleagues to consider this legislation and also to consider cosponsoring this bill with me.

I ask unanimous consent that a GAO summary, and the text of the bill, be printed in the RECORD.

There being no objection, the additional material was ordered to be printed in the Record, as follows:

Washington, DC, May 7, 2004

Subject: Military Personnel: Active Duty Compensation and Its Tax Treatment..


Ranking Minority Member, Committee on Finance, U.S. Senate,

U.S. Senate.

The Department of Defense's (DOD) total military compensation package for active duty members consists of both cash and noncash benefits. Since the late 1990s, Congress and the DOD have increased military cash compensation by increasing basic pay and allowances for housing, among other things. Military members also receive tax breaks, which are a part of their cash compensation. Moreover, active duty personnel are offered substantial noncash benefits, such as retirement, health care, commissaries, and childcare. In some cases, these noncash benefits exceed those available to private-sector personnel. DOD relies heavily on noncash benefits because it views benefits as critical to morale, retention, and the quality of life for service members and their families.

To better understand the military compensation system, you asked us to provide you information on active duty military compensation and its tax treatment. At the outset of this engagement, we agreed to keep you periodically informed of the status of our work. In January 2004, we briefed your staff on our preliminary observations. Because our work identified that the combat zone tax exclusion could impact some service members, you asked us to focus our work on military cash compensation and to do additional work to estimate the effect of the combat zone tax exclusion on service members' compensation. We provided your staff subsequent briefings that estimated the effect of the combat zone exclusion. As requested, we have updated and combined the briefings for this report to (1) summarize active duty cash compensation and describe how military compensation varies at different career points for officers and enlisted members; (2) explain how military pay is taxed and any special tax treatment of military compensation; (3) estimate the effects of interactions between the combat zone exclusion and certain tax credits on military members' compensation; and (4) describe the benefits DOD provides active duty members as well as specific programs available to members that encourage wealth building (see enclosure I). To provide a rough estimate of the number of service members in 2003 who suffered a net tax loss because of the interactions between serving in a combat zone and certain tax credits, we used aggregate data compiled by the Defense Manpower Data Center on the number of members who served in a combat zone in 2003 and aggregate data on the percentage of spouses not in the workforce from the 2002 Active Duty Survey. We believe that the data is sufficiently reliable to estimate within a broad range the number of people affected. We conducted our review from October 2003 through April 2004 in accordance with generally accepted government auditing standards.


The foundation of military cash compensation is what the DOD calls regular military compensation-the sum of basic pay, nontaxable allowances for housing and subsistence, and the associated federal tax savings. Some members also receive additional cash compensation in the form of special pays, incentives, and other allowances. In total, there are over 50 of these pays, incentives, and allowances, ranging from reenlistment bonuses to clothing allowances and family separation allowances.
The annual amounts of these pays, incentives, and allowances range from a few hundred dollars to thousands of dollars, and some of these are also nontaxable. In general, regular military compensation progresses steadily with pay grade and years of service. For example, a junior enlisted member with 3 years of service might earn around $40,000 in cash compensation, while
a senior officer with 22 years of service could earn cash compensation of about $130,000.

Military service brings with it significant tax advantages. Basic pay and most other pays are generally subject to federal income tax; however, certain allowances are not taxed, such as the basic allowances for housing and subsistence. DOD considers the federal tax advantage as the additional income military members would have to earn in order to receive their current take-home pay if their allowances for housing and subsistence were taxable. In fact, DOD views the federal tax advantage as part of service members' cash compensation when it compares military pay with civilian pay. In addition, pay earned-including basic pay, bonuses, special pays, and allowances-while members are serving in one of the 15 designated combat zones is excluded from taxes.

The complex interactions between the combat zone exclusion and certain tax credits (principally the Earned Income Tax Credit and the Additional Child Tax Credit) appear to be creating unintended consequences. Specifically, some low-income- earning service members who serve in a combat zone are worse off for tax purposes, while some higher-income-earning members are better off because they become eligible for a tax credit that is normally targeted to low-income workers. Low-income members with children qualify for refundable tax credits that can not only offset all of their tax liability but can also leave them with payments from the government. The combat zone exclusion can actually cause a reduction or elimination of these payments to some service members. For example, over certain income ranges the amount of Earned Income Tax Credit that a taxpayer earns increases as his or her income increases. Service in a combat zone reduces the amount of earned income that a member reports for tax purposes and, thus, can reduce or eliminate the refunded portion of the member's credit. These members actually suffer a net loss in tax benefits because they receive no offsetting advantage from the exclusion. Our analysis suggests that some of the roughly 430,000 members serving in a combat zone in 2003-between 5,000 and 10,000 members in one-earner households-suffered a net loss of tax benefits. Data limitations make it difficult to produce a comprehensive estimate of the number of members who suffered a net loss of tax benefits. In particular, it is more difficult to make a reliable estimate of the number of members with working spouses who had net losses of tax benefits. However, we believe that number is not likely to be much higher than several thousand and could be less than that. Additionally, the number of members losing tax benefits could be larger in 2004 depending on the how many service members are in a combat zone and how long they are there. The amount of the tax benefit loss varies considerably, with a maximum of about $4,500 or $3,200, for enlisted and officer members, respectively. In general, the members losing tax benefits tend to be those who are serving in a combat zone longer than 6 months; who are in the lower pay grades; who are married with children; and who have little to no investment or spousal income. On the other hand, some other low-income members earned larger earned income tax credits by serving in a combat zone than they otherwise would have. Moreover, it appears that a large number of service members who had incomes exceeding the normal upper limit for Earned Income Tax Credit eligibility and who served in a combat zone for at least 6 months could become eligible to receive that credit as a result of this income exclusion. DOD is aware of service members who are disadvantaged and advantaged by these tax provisions, and it is seeking remedies that would require changing the rules of the tax credits so that income earned in a combat zone would not be excluded when calculating eligibility for the tax credits.

Benefits are a substantial portion of noncash military compensation. DOD offers a wide range of benefits to active duty members, including health care, retirement, education assistance, and installation-based benefits-that is, services found on military installations, such as commissaries and child care. While the value of benefits to members varies depending on the members' needs, the cost to provide such benefits is substantial. Some of the benefits DOD provides encourage wealth building over a service member's career. Military retirement-a lifetime annuity generally provided to members who serve 20 years or more-is one of the primary wealth-building programs available to military members. However, DOD estimates that less than half of officers and only about 15 percent of enlisted members will become eligible for retirement. In addition, other savings programs are offered, such as the Thrift Savings Plan and the Savings Deposit Program. Since 2001, service members can contribute a percentage of their basic pay, before taxes, to be invested in one or more of the specific funds offered through the
Thrift Savings Plan; about 21 percent of the active duty military participate. Service members deployed to a combat zone or other qualified areas can contribute to the Savings Deposit Program, earning a guaranteed 10 percent interest on their investment. However, less than 1 percent of the active duty force participates. Service members may also be eligible to participate in the Department of Veterans Affairs no-money down, mortgage-backed loan program. Moreover, military members can take advantage of a number of wealth-building tax provisions available to citizens, such as deductions for mortgage interest and tax credits for elective retirement accounts contributions.


If the Congress wishes to remedy the unintended tax consequences associated with the combat zone exclusion, it should consider revising the rules of the Earned Income Tax Credit and the Additional Child Tax Credit with respect to income earned in a combat zone.


Our audit work focused on military cash compensation and its tax treatment for active duty service members. To summarize the components of active duty military members' compensation, we reviewed policies, publications, and regulations governing military compensation. We interviewed officials from the Office of the Secretary of Defense and the Defense Manpower Data Center. We compiled 2003 data for basic pay tables, basic allowances for housing and subsistence rates, special pay amounts, incentive pay amounts, and allowance pay amounts. To describe how military compensation varies at different career points for officers and enlisted members, we created notional junior and senior enlisted service members and officers.
We assigned these hypothetical service members typical years of service for their pay grades, locations across the United States, numbers of dependents, and special pays typical of their pay grades and locations. We discussed our examples with officials from the Office of the Under Secretary of Defense for Personnel and Readiness to ensure that our profiles were reasonable. We identified benefits offered to active duty military members and some associated values by reviewing past GAO reports, DOD documents, and the fiscal year 2002 DOD Actuarial Valuation Report.

To explain how military pay is taxed and any special tax treatment of military compensation, we reviewed DOD policies and regulations and the Internal Revenue Services' 2003 Armed Forces Tax Guide publication. To estimate the federal tax advantage of the exclusion of the housing and subsistence allowances from taxation, we estimated the tax liability for hypothetical members according to current tax rules as if the members' housing and subsistence allowances were taxable. We present the pre-tax value of this tax advantage-that is, the additional income the members would have to earn in order to receive their current take home pay if their allowances were taxable.

To estimate certain effects of the combat zone exclusion on military members' taxes, we estimated the number of members negatively affected and the number who may become eligible for Earned Income Tax Credit by the combat zone tax exclusion. For more detailed information on how we estimated the combat zone effect, see enclosure II.

To describe programs available to members that encourage wealth building, we reviewed documents and interviewed officials from the Office of the Secretary of Defense and the Department of Veterans Affairs. In addition, we also reviewed other documents to identify tax provisions that encourage wealth building for citizens.


In providing oral comments on a draft of this report, DOD representatives from the Office of the Under Secretary of Defense for Personnel and Readiness stated that they generally concurred with the content of the report. Technical comments were incorporated as appropriate. DOD officials told us that they have been seeking to remedy the unintended tax consequence related to the combat zone tax exclusion. We also received comments on the tax-related sections of our draft from Internal
Revenue Service (IRS). In providing oral comments, IRS representatives from the Office of the Commissioner, Wage and Investment Division and the Office of Legislative Affairs said that the IRS could administer a change in law that would include combat pay in earned income for purposes of computing eligibility for the Earned Income Tax Credit. Since earned income
used for computing Earned Income Tax Credit is not reported anywhere on the IRS form 1040 or Schedule EIC, IRS would modify the Earned Income Tax Credit worksheets and related instructions to account for the combat zone pay. In addition, they would work with DOD to develop a process for identifying and processing returns from taxpayers who would be affected by this provision. The representatives noted that, although at the outset the process would likely be primarily manual, IRS would explore options for automation. The IRS officials also provided technical comments relating to the child tax credit, which we incorporated as appropriate, and made the point that changes to the treatment of income earned in a combat zone for the purposes of the two credits could affect other tax benefits, such as the dependent care credit and the exclusion for employer-provided benefits under a dependent care assistance program, depending on the specific wording of the changes. We also spoke to the Department of Treasury staff about the tax-related sections of our briefing documents and incorporated their technical comments as appropriate.

As arranged with your office, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days from its issue date. At that time, we will send copies of this report to the Secretary of Defense and the Commissioner of the Internal Revenue Service. We will also make copies available to appropriate congressional committees and to other interested parties on request. In addition, the report will be available at no charge on our Web site at

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