Minnesota Income Tax Credit for Past Military Service | MN Tax Lawyer

What is the income tax credit for past military service?

The 2008 omnibus tax bill (Laws 2008, ch. 366) provided for a new income tax credit for past military service. The credit equals $750 for qualifying individuals. It is nonrefundable and is subject to an income limitation. The credit took effect in tax year 2009 and was first claimed on tax year 2009 returns filed in 2010.

Who qualifies for the credit for past military service?

To qualify for the credit, a veteran must:

  • have served in the military (including the National Guard and reserves) for at least 20 years; or
  • have a service-connected disability rated by the U.S. Department of Veterans Affairs as being 100 percent total and permanent.

Individuals currently serving in the military do not qualify for the credit.

What is a nonrefundable credit?

A nonrefundable credit may be used only to offset Minnesota income tax liability. A veteran must have at least $750 of income tax liability to receive the full credit amount. A qualified veteran with less than $750 of state income tax liability is eligible for a credit only up to the amount of tax. A qualified veteran with no state income tax liability is not eligible for a credit. In tax year 2012, a single veteran with no dependents who claims the standard deduction would need to have $23,770 of federal adjusted gross income to receive the full $750 credit.

How does a nonrefundable credit compare with an income tax subtraction?

A nonrefundable credit has an effect on final liability similar to that of an income tax subtraction. A credit is a dollar-for-dollar reduction in tax liability, while a subtraction reduces taxable income, which results in lower tax liability. The benefit from a subtraction depends upon the taxpayer’s tax bracket or rate. Because of the income limits, veterans who qualify for the credit will be in the bottom or lowest tax bracket with a rate of 5.35 percent. The $750 nonrefundable military service credit is equivalent to a $14,020 income tax subtraction ($14,020 times 5.35 percent, the state income tax rate for the first bracket of taxable income, equals $750). Only individuals with tax liability will benefit from either a nonrefundable credit or a subtraction, and the amount of the benefit is limited to their tax liability.

How is the military service credit income limited?

The military service credit is phased out for individuals with federal adjusted gross income (FAGI) of $30,000 or more. The credit is reduced by 10 percent of FAGI in excess of $30,000, so that individuals with FAGI over $37,500 are not eligible for any portion of the credit. FAGI is calculated on the federal tax forms (Form 1040, 1040A, or 1040EZ). It includes most kinds of income, such as:

  • wages, salaries, and tips;
  • taxable interest;
  • dividends and capital gains or losses;
  • business income or loss, including income from partnerships and Scorporations;taxable IRA, pension, and annuity distributions;
  • farm income or loss;
  • unemployment compensation; and
  • taxable Social Security benefits (the amount of Social Security benefits that are taxable depends on the individual’s income level; at most, 85 percent of benefits are included in federal adjusted gross income).

Some of the major items excluded from FAGI are:

  • deductible retirement plan contributions;
  • nontaxable employee fringe benefits;
  • student loan interest payments;
  • one-half of self-employment tax;
  • health insurance premiums (for self-employed taxpayers only);
  • tax-exempt bond interest; and
  • veterans disability payments.

What are some examples of individuals who will and will not receive the new military service credit?

Qualifying veterans with less than $30,000 in taxable military retirement income and no other income other than Social Security would qualify for part or all of the credit, depending on the individual’s tax liability. Since Social Security benefits are not included in FAGI for low-income filers, receipt of Social Security will not subject an individual to the income-based phaseout. Qualifying veterans who are 100 percent totally and permanently disabled may or may not receive the credit, depending on their amount of taxable income (military disability compensation itself is nontaxable). With no taxable income or with more than $37,500 of adjusted gross income, such disabled veterans do not receive the credit. Conversely, with any amount of taxable income greater than zero and less than $37,500, the disabled veteran would receive a credit.

How many individuals claimed the credit in 2009, and how much did they claim?

In tax year 2009, 1,507 returns claimed about $970,000 in credits, for an average credit of $646. In tax year 2010, 1,616 returns claimed about $1.065 million in credits, for an average of $659. Usage of the credit in the first two years it was in effect has been stable and was substantially lower than the estimate prepared when the credit was enacted in 2008, which projected that about 14,000 veterans would claim $10.3 million in credits.

This and any related posts have been adopted from the Minnesota House of Representatives Research Department’s Information Brief, Minnesota Income Tax Credit for Past Military Service, written by legislative analysts Nina Manzi and Jim Cleary.