Military pay and Earned Income Credit

For purposes of EIC, earned income includes:

• Wages, salaries, tips and other taxable employee pay (box 1 of the W-2)

• Net earnings from self-employment (Schedule C)

• Gross income received as a statutory employee (box 1 of the W-2)

• Nontaxable combat pay if you elect to include it in earned income (box 12 of the W-2 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 W-2 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 located on the EIC screen starting in Drake Tax 2021 (8812 screen in Drake20 and prior).

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

• number of qualifying children

See Publication 596, to determine if the taxpayer will benefit from including combat pay in earned income. Also see Publication 3524, and Publication 3 for more information.