How does military pay factor into the Earned Income Credit?
For purposes of EIC, earned income includes:
- Wages, salaries, tips and other taxable employee pay (box 1 of the W2)
- Net earnings from self-employment (Schedule C)
- Gross income received as a statutory employee (box 1 of the W2)
- Nontaxable combat pay if you elect to include it in earned income (box 12 of the W2 coded Q)
For purposes of EIC (where military income is involved), earned income does not include:
- Basic pay or special, bonus, or other incentive pay subject to the combat zone exclusion (unless you elect to include combat pay in earned income)
- Basic Allowance for Housing (BAH)
- Basic Allowance for Subsistence (BAS)
- Veterans’ benefits (including VA rehabilitation payments)
A taxpayer can elect to include nontaxable combat pay in earned income to claim EIC. If they make the election, they must include in earned income all nontaxable combat pay received. If both the taxpayer and their spouse received nontaxable combat pay, each taxpayer can make his or her own election. The amount of nontaxable combat pay should be shown in box 12 of Form W2 with the code of Q.
If the only income is combat pay, the software will include it in the EIC calculation. If there is income beyond the combat pay, the software will determine whether or not it is of benefit to the taxpayer to include the combat pay in the EIC calculation.
The election to include combat pay in earned income in the EIC calculation is also located on the 8812 screen in Drake Tax under the section Combat Pay.
Note: Combat pay entered on a W2 will automatically be included in earned income for the Additional Child Tax Credit calculation.
First, figure the amount of EIC without combat pay included, then figure it with the amount included. Whether or not the election will increase EIC depends on several factors:
- total earned income,
- filing status, and
- The number of qualifying children.
If the amount of earned income without combat pay is equal to or more than the following amounts, you will not benefit from including combat pay in earned income.
- $7,030 if you have no children.
- $10,540 if you have one child.
- $14,800 if you have two or more children
See Publication 596, Earned Income Credit, or Publication 3524, EITC Eligibility Checklist, for more information about the Earned Income (Tax) Credit. Information is provided specifically for those in the armed forces in Publication 3, Armed Forces’ Tax Guide.