Tax Considerations & Advice for
Taxpayers in the Mideast

WASHINGTON - The Internal Revenue Service today provided guidance, in the form of answers to frequently-asked questions, on tax issues of concern to military reservists and others affected by recent events in the Middle East.

Today's announcement includes guidance for reservists on a provision of the Soldiers' and Sailors' Civil Relief Act of 1940 which offers additional time to pay an outstanding tax assessment.

Because many taxpayers in the Mideast have spouses in the United States, the IRS has included guidance on obtaining powers of attorney so that the spouse at home can take care of federal tax matters requiring joint signature.

Also included are answers to questions about relief from requirements for the foreign earned income exclusion and the moving expense deduction available to taxpayers who had to leave areas of the Middle East unexpectedly.

A complete set of the questions and answers on these and other issues affecting reservists, regular military personnel, civilians and those being held hostage by the government of Iraq is attached.

QUESTIONS AND ANSWERS ON FEDERAL TAX ISSUES FOR TAXPAYERS IN THE MIDEAST AND THEIR FAMILIES

Q1: As a reservist called to active duty in support of Operation Desert Shield I receive allowances similar to those provided regular military personnel. Are these exempt from tax?

A1: Among the allowances you may receive tax-free are BAQ (basic allowance for quarters), BAS (basic allowances for subsistence), certain family allowances, and uniform allowances for officers and enlisted personnel.

However, as with the regular military, special pay for foreign or hazardous duty is subject to tax.

IRS Publication 3, Tax Information for Military Personnel, contains a complete list of allowances and payments which are excludable from gross income in computing your taxes. It also lists payments and bonuses that are taxable to military personnel.

Q2: Because I am a reservist called to active military duty, I am unable to pay past due federal income taxes that I owe. Can I get an extension of time to pay an income tax assessment for these back taxes?

A2: Reservists called to active duty and regular military personnel may request a deferment of the collection of past due tax. If granted, no penalty or interest will be charged on the back taxes for the period of time the deferment is in effect. Certain conditions must be met to be eligible for deferment and approval must be granted by the IRS. To obtain a deferment, you have to be serving in your "initial period of service" and you have to show that your ability to pay the back taxes has been "materially impaired."

The "initial period of service" is defined as the period of active duty following recall to active duty from an inactive reserve or National Guard unit. For regular military personnel it is the period following induction or first enlistment in the armed forces or the first period of reenlistment for a person who has been out of the service for a year or more. For an officer, the initial period of service is limited to two years of active service after one of the above occurrences.

In order to show material impairment you will need to show that your income dropped as a result of going into military service.

Q3: How would I seek approval from IRS to defer payment of back income tax if my active reserve duty impairs me financially?

A3: You can call the IRS at 1-800-829-1040 and request that you be sent a form called "Request for Deferment of Collection of Income Tax" (form letter 1175). The completed form should be mailed to the IRS office that previously contacted you by telephone, bill or in person about the back tax due.

As an alternative, you may send a letter to IRS providing your name, social security number, monthly income and source of income before military service, monthly income currently, military rank, date you entered military service, and date you are eligible for discharge.

It would be helpful to attach to your request a copy of your orders to report for military service. The IRS will evaluate your request and advise you in writing if deferment of payment is granted.

Q4: How much additional time will I be granted to pay back taxes if deferment is granted?

A4: If your request for deferment is granted by IRS you will be able to defer payment of back tax until six months after the end of your initial period of service.

Q5: I have heard a lot about how reservists called to active duty can get their interest rate on outstanding debt reduced to six percent. Will the IRS reduce interest on back taxes to six percent?

A5: Reservists who have been called to active duty generally will quality for a deferment of payment on their back taxes, without interest, if ability to pay has been severely impaired. In those instances where they do not meet this test, the IRS generally will grant a reduction of interest to the six percent rate on tax liabilities that arose before they entered active service. This applies to reservists and regular military personnel during their period of active service.

Q6: Will the money I save due to a reduction in my interest rate on outstanding debt need to be reported as taxable income on my tax return?

A6: The reduction to six percent maximum interest is provided for by law. For that reason, the portion of interest you are not charged (the amount in excess of six percent) is not taxable.

Those who itemize deductions on their tax returns may, as a result of reduced interest payments, end up with smaller interest deductions, particularly deductible mortgage interest. This would have the effect of increasing taxable income. Adjustments to withholding or estimated tax payments should be considered to avoid having too little tax paid prior to filing.

Q7: Will I still be covered by my employer-provided health plan when I report for active duty as a reservist?

A7: Employers must offer to reservists and their families an opportunity for continued health coverage, even though these individuals will be covered under military health plans. Employers may choose to voluntarily maintain the health coverage of these employees while they are on active military duty. If not, group health plans generally are required to offer reservists, and their families if covered under the plan, an election to continue coverage at their own expense.

Q8: I sold my house just before I heard I was going to be called up to active duty. How long do I have to replace it and still postpone tax on the gain?

A8: The general rule is that can you postpone paying tax on capital gains from the sale of principal residence if you buy a new one within two years before or after you sold the old one. If you are on extended active duty in the Armed Forces, the time for replacing your old residence is extended for two more years. That allows you up to four years after selling an old residence to replace it and still postpone the gain. Extended active duty is defined as a call up for more than 90 days or for an indefinite period.

If you are on extended active duty outside the United States, the replacement period described above is suspended to one year after the last day you are stationed outside the country. However, the total replacement period is limited to eight years after you sold your old residence.

Q9: Because my wife is being called up to active military reserve duty I will not be able to get her signature very easily on tax returns or other documents. Will the IRS accept my signature only?

A9: On a joint income tax return the signature of both husband and wife are needed. In order to avoid having to mail tax documents to your spouse to obtain a signature, the IRS encourages taxpayers in this situation to obtain a power of attorney. This empowers someone else to sign the income tax return on behalf of a taxpayer who is unable to do so because of absence or disability.

A properly completed IRS Form 2848, "Power of Attorney and Declaration of Representative," should be used for this purpose. However, IRS will accept a properly completed general power of attorney that specifically authorizes a person to prepare, execute and file income tax returns. A copy of the power of attorney should be attached to any return or document for which you are signing for your spouse.

Q10: My husband is being detained by the government of Iraq and I received a notice from IRS about our 1988 taxes. Can I postpone this matter with the IRS?

A10: The IRS will suspend examination and collection actions for individuals, including civilians, detained by Iraq for the period of their detention. In addition, any penalties charged during the period of detention will generally be waived upon the showing of reasonable cause. Relatives, friends or employers of these individuals are encouraged to call a special IRS toll-free number, 1-800-829-4351, as soon as possible, so that IRS can take steps to suspend any collection or examination activities.

Q11: What can families of individuals being detained by the Iraqi government do about the problem of getting needed signatures and filing tax returns.

A11: Individuals who are detained by the Iraqi government probably will be unable to file returns until their release, unless they had previously granted someone power of attorney to perform that duty on their behalf.

However, those who are detained in a foreign country against their will are allowed additional time to file their federal income tax returns. The due date for filing is extended until the fifteenth day of the third month following their release. This extension is for all detained taxpayers, including military personnel, U.S. Government employees and others.

For married persons filing a joint income tax return, both spouses qualify for this extension even if only one is detained. For married persons filing separately, only the detained spouse qualifies for the extension.

Because this extension is not applied for, IRS should be contacted by relatives or friends of detainees at 1-800-829-4351 so that IRS can know who may need to file after the normal deadline.

Q12: I had to leave Kuwait suddenly because of the Iraqi invasion. Can I claim the foreign earned income exclusion even though I didn't meet the tests for bona fide residence or physical presence?

A12: Individuals who are not employees of the U.S. government may claim on their tax return an exclusion of up to $70,000 of foreign earned income if they meet certain requirements. Your tax home must be in a foreign country and you must either be a bona fide resident of a foreign country for an entire tax year, or be physically present for at least 330 days during any period of 12 consecutive months.

Due to adverse conditions in Iraq, Kuwait, Libya, and Yemen, the bona fide residence and physical presence tests have been waived for those countries. That means if you otherwise would have qualified for the foreign earned income exclusion by virtue of establishing a tax home in one of those countries, you can still claim the credit even though you had to leave before meeting either the bona fide residence or physical presence tests.

Q13: I took a job in the Middle East last March. Can I still claim my moving expenses as a tax deduction even though I had to leave unexpectedly before meeting the time requirement for employment there?

A13: Yes, if you can show that you could reasonable have been expected to meet the requirement for the minimum period of employment, but that the Middle East crisis made it impossible for you to stay on the job long enough to meet this test.

Normally, to satisfy the minimum period of employment, you have to be employed full time for at least 39 weeks during the first 12 months after arriving in the general area of your new job location. You do not have to work consecutive weeks or work for the same employer to satisfy this requirement. Self-employed individuals have to meet the 39 week test for the first 12 months, and have to work full-time for a total of 78 weeks during the first 24 months after arriving in the area of the new job.

In addition, there are requirements involving distance from your old job location, generally no problem when you move overseas, and the moving expenses have to be incurred within one year from the date you first report to work at the new location.

Q14: My husband is in Saudi Arabia and up until this year had always prepared out tax returns. Now that he's not home, where can we get help?

A14: Free help is available from IRS-trained tax assistors by calling 1-800-829-1040, toll-free. Also, you can call 1-800-829-3676 to order any of the nearly 150 free tax instruction publications or 1-800-829-4477 to listen to a series of recorded tax information taxes.

During the January through April 15 tax filing season, Volunteer Income Tax Assistance (VITA) is available throughout the country to help persons with relatively simple tax returns. At that time, you can call 1-800-829-1040 to find the VITA site nearest you.

Taxpayers living abroad can get information about overseas tax assistance locations by calling their nearest U.S. embassy or consulate. In addition, VITA help is offered at numerous U.S. military bases and other overseas locations. Contact your JAG officer or the IRS for more information.

The IRS has an overseas office in Riyadh, Saudi Arabia, as well as in Bonn, Caracas, London, Mexico City, Nassau, Ottawa, Paris, Rome, Sao Paulo, Singapore, Sydney and Tokyo. Overseas military and civilian taxpayers also can get information and answers to their tax questions by calling the IRS International tax assistance office in Washington, D.C. at (202) 287-4301.

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