You know that basic pay, allowances and bonuses received while in a combat zone are tax free.
But did you know that if you're in a combat zone for all or most of the year and don't have a working spouse or are single, you may have negative taxable income after subtracting the personal exemption, standard deduction or itemized deductions?
As a certified public accountant, I find the idea of unused deductions that go to waste repugnant. A better idea is to increase your income to use up those lost deductions. And what better way to do this than to convert some or all of your regular IRA balances to a Roth IRA during your year of negative income?
In addition, if your adjusted gross income is low enough, you can receive a retirement savings contribution tax credit of up to $1,000 for single taxpayers and $2,000 for married taxpayers.
You do not get a tax deduction for contributions to a Roth IRA as you usually do with a regular IRA, but the benefits of a Roth IRA are so attractive that they far outweigh the loss of a deduction.
Regular IRAs can be converted to a Roth IRA if the taxpayer's total adjusted gross income is less than $100,000. This would include income earned or received by the spouse if filing a joint return. It is important to note that this conversion is always taxable whether you are in a combat zone or not. However, this taxable income will help use up some or all of those unused deductions mentioned above.
For example: Two E-6s, one married with children and the other single, are stationed in Iraq for 10 months of 2005. Each has $10,000 in a regular IRA from contributions from previous years. They must set up a Roth IRA, even if just before the conversion, to have someplace to send the regular IRA funds.
Tables 1 and 2 illustrate how converting a regular IRA to a Roth IRA during a deployment year can be a really good idea with minimal or no cost in additional taxes.
Note: The spouse of the married service member could convert her own regular IRA to a Roth IRA. If the spouse's regular IRA account was valued at $7,592, the couple could convert a total of $17,592 in regular IRAs to Roth IRAs without incurring tax on the transaction. Each spouse would have a separate Roth IRA account after conversion, and no taxes would ever be due on the future distributions from the accounts.
But Table 2 shows that the single service member is left with a tax bill of $701. Here is where the Retirement Savings Contributions Credit comes in.
Let's assume that our single service member made a Roth IRA contribution for 2005 for the maximum amount of $4,000. His taxable income is $7,008 and his taxable wage income is $5,208 (two months' pay). By filing Form 8880 (Credit for Qualified Retirement Savings) with his tax return, he can claim a credit of $701, which will reduce his tax to zero. In fact, he could earn another $2,992 in taxable income before he would pay any tax at all because of the retirement tax credit.
Here's how it works: A single taxpayer is allowed a tax credit equal to 50 percent of the first $2,000 contributed to a retirement account if adjusted gross income is less than $15,000. A smaller credit is available at higher income levels. If both married taxpayers make a retirement contribution, the credit increases to $2,000. For married couples, the income limitation is $30,000 to obtain the full credit for either one or two contributions.
These rates, credits and income limitations are illustrated in Table 3. Note: If the service member is single and deployed in a combat zone for a full tax year and has no other taxable wage or self employment income, he cannot make an IRA contribution. If the married service member has a working spouse, he can make a retirement contribution based on the spouse's wage or self employment income.
Barbara H. Pietrowski is a licensed certified public accountant, certified financial planner and personal financial specialist. E-mail her at firstname.lastname@example.org.