[Congressional Record Volume 150, Number 67 (Thursday, May 13, 2004)]
[Senate]
[Pages S5475-S5477]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      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:

                                    General Accounting Office,

                                       Washington, DC, May 7, 2004
     Subject: Military Personnel: Active Duty Compensation and Its 
         Tax Treatment.

     .Hon. Charles E. Grassley,
     Chairman,
     Hon. Max S. Baucus,
     Ranking Minority Member, Committee on Finance, U.S. Senate,
     Hon. Mark Pryor,
     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

[[Page S5476]]

     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.

                            Results in Brief

       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.

                 Matter for Congressional Consideration

       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.

                         Scope and Methodology

       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.

[[Page S5477]]

                            Agency Comments

       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 http://www.gao.gov.
 If you or your staff have any questions about this report, 
     please contact Derek Stewart, (202) 512-5559, or James White, 
     (202) 512-5594, or e-mail them at [email protected] or 
     [email protected], respectively. Key contributors to this report 
     were Lori Atkinson, Jennifer Gravelle, John Pendleton, Sonja 
     Ware, and James Wozny.
     Derek B. Stewart,
       Director, Defense Capabilities and Management.
     James R. White,
       Director, Strategic Issues.
                                  ____


                                S. 2419

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Tax Relief for Americans in 
     Combat Act''.

     SEC. 2. EARNED INCOME INCLUDES COMBAT PAY.

       (a) Child Tax Credit.--Section 24(d)(1) of the Internal 
     Revenue Code of 1986 (relating to portion of credit 
     refundable) is amended by adding at the end the following new 
     sentence: ``For purposes of subparagraph (B), any amount 
     excluded from gross income by reason of section 112 shall be 
     treated as earned income which is taken into account in 
     computing taxable income for the taxable year.''.
       (b) Earned Income Tax Credit.--Subparagraph (B) of section 
     32(c)(2) of the Internal Revenue Code of 1986 (relating to 
     earned income) is amended--
       (1) by striking ``and'' at the end of clause (iv),
       (2) by striking the period at the end of clause (v) and 
     inserting ``, and'', and
       (3) by adding at the end the following:
       ``(vi) any amount excluded from gross income by reason of 
     section 112 shall be treated as earned income.

     Any taxpayer may elect to not apply clause (vi) with respect 
     to any taxable year ending after the date of the enactment of 
     such clause and before 2005.''.
       (c) Effective Date.--The amendments made by this section 
     shall apply to taxable years ending after the date of the 
     enactment of this Act.

  Mr. BAUCUS. Mr. President, I rise today to join my good friend from 
Arkansas, Senator Pryor, in introducing the Tax Relief for Americans in 
Combat Act. I applaud Senator Pryor for his commitment to our Armed 
Forces. The study and the bill that he has unveiled today provide just 
one example of that commitment.
  Last year, Senator Pryor asked me to join him in requesting a study 
on the compensation received by our military personnel, and the tax 
treatment of this compensation. This study has been completed. Many of 
the results are encouraging. But the study reveals one significant 
glitch in the tax law that is hurting many of our low-income military 
personnel.
  For the most part, the compensation packages received by our military 
personnel are competitive with the private sector. And the Tax Code 
provides many incentives for military service. But as the GAO study 
reveals, some low-income military personnel are losing out because they 
have been called to serve in a combat zone.
  Now this just does not make sense. Why would we penalize those 
military personnel who are serving our country in Afghanistan, Iraq, 
and elsewhere around the world?
  Let me explain. Under current law, compensation earned by military 
personnel while they are serving in a combat zone is exempt from income 
tax. This provides most military personnel in these areas with a very 
significant tax benefit. Because of a glitch in the tax law, however, 
certain individuals may actually end up losing money because of this 
exemption.
  This is because the law is preventing them from receiving the Earned 
Income Tax Credit and Refundable Child Tax Credit that they would 
otherwise been entitled to. These credits are based on earned income, 
and the law says that combat zone income does not qualify as earned 
income. GAO has found that as many as 10,000 men and women serving in 
combat will see a reduction or elimination of their EITC or child 
credit, they will, in effect, lose money.
  This bill would fix that glitch in the law, and provide these 
individuals with the tax credits to which they are entitled.
  Our brave men and women in the Armed Forces put their lives on the 
line for our Nation every day. It is the least we can do to ensure that 
they are being properly compensated and receiving all the tax benefits 
that are due to them under the law. Given the ongoing conflict in Iraq 
and the war on terrorism, it is more important than ever that we 
vigilantly oversee the tax system to ensure that our troops are being 
treated fairly.
  I applaud Senator Pryor for taking the lead. I am proud to join him 
in introducing legislation to correct these errors and ensure our 
service men and women receive the proper level of tax relief they 
deserve. Serving our country is one of the most honorable services a 
citizen can provide. Now it is up to us to provide them with the tax 
compensation they are due.
  I hope that the Senate will take up and pass this bill at the 
earliest appropriate time, and make sure that our men and women in 
uniform receive the tax relief to which they are entitled.
                                 ______