MILITARY MODULE STUDENT TEXT

For Use in Preparing Tax Year 2002 Returns

Department of the Treasury

Internal Revenue Service

Publication 678-M (Rev. 2002) IRSCatalog Number 46676K www.irs.gov

IRS VOLUNTEERS

VOLUNTEERASSISTOR'SGUIDE

FOR USE IN IRS VOLUNTEER PROGRAMS

VITA Volunteer Income Tax Assistance

TCE Tax Counseling for the Elderly
Important Changes and Reminders for 2002......................... iii

Introduction ................................................................................ ix

Lesson 1. Gross Income........................................................ 1-1

Lesson 2. Foreign Earned Income Exclusion..................... 2-1

Lesson 3. Tax Benefits for Combat Zone Participants..... 3-1

Lesson 4. Aliens...................................................................... 4-1

Lesson 5. Filing Status........................................................... 5-1

Lesson 6. Dependency Exemptions .................................... 6-1

Lesson 7. Claiming a Foreign Dependent or Spouse ....... 7-1

Lesson 8. Taxpayer Identification Number and

Other Entity Issues .............................................. 8-1

Lesson 9. Foreign Tax Credit ................................................ 9-1

Lesson 10. Earned Income Credit.......................................... 10-1

Lesson 11. Sale of Home......................................................... 11-1

Lesson 12. Moving Expenses ................................................. 12-1

Lesson 13. Travel Expenses.................................................... 13-1

Lesson 14. Miscellaneous Itemized Deductions................. 14-1

Lesson 15. Filing Returns ........................................................ 15-1

Lesson 16. Education Benefits............................................... 16-1

Lesson 17. IRAs/TSPs .............................................................. 17-1

Lesson 18. Other Income ........................................................ 18-1

Summary Problems ................................................................... SP-1

Answers to Summary Problems .............................................ASP-1

Comrehensive Test Questions for Military Issues ............... T-1

Answers to Comrehensive Test Questions

for Military Issues...................................................................... T-3

Table of Contents

TABLE OF CONTENTS
WELCOME, VOLUNTEERS! 

Through the assistance of trained tax preparers from the U.S. Armed Forces, the Internal 

Revenue Service is able to offer free tax assistance to members of the military in all regular and 

reserve units. 

Publication 678M, the Military Supplement, when used with the Publication 678, Volunteer 

Assistor’s Guide, will help you to acquire the skills to prepare tax returns for the military. The 

Military Supplement focuses on tax issues unique to the Armed Forces, such as the taxability of 

combat pay. The Publication 678 provides training on general tax issues faced by individuals in 

the low to moderate-income ranges. 

MC-VITA. I am pleased this year to offer you another tax preparation tool. We developed a 

handy reference guide designed to be used with the Service’s designated software. It includes 

screen shots for most entries on the Form 1040 and related forms and worksheets. This guide 

will be provided automatically with each Publication 678M. 

Comments and recommendations. I welcome your comments and recommendations about 

our training material and suggestions for future editions. Your instructor or tax center 

coordinator can take your suggestions or you can write to us at the following address: 

 Internal Revenue Service 

 Stakeholder Partnerships, Education and Communication 

 W:CAR:SPEC:PPD:E, Stop 45-WI 

 401 Peachtree Street, NW 

 Atlanta, GA 30308 

I thank you in advance for your willingness to volunteer your own time to provide this much 

needed service to your neighbors and your community. 

 Sincerely, 

 Mark E. Pursley 

Director, Stakeholder Partnerships, 

Education and Communication 
This section summarizes important tax changes that take effect

in 2002 and important reminders that could affect your income

tax return.

Standard Mileage Rate

For 2002, the optional standard mileage rate for operating your

car for business purposes is 36.5 cents for each business mile.

The mileage rate for operating your car to get medical care is

13 cents a mile.

Afghanistan Designated a Combat Zone

By Executive Order No. 13239, Afghanistan is designated as a

combat zone beginning September 19, 2001. When you file,

write “Enduring Freedom” at the top of your return and on the

envelope in which you mail it. For more information on benefits

available to members of the Armed Forces serving in combat

zones, see Publication 3, Armed Forces’ Tax Guide.

Tax Benefits for Education

The following paragraphs explain the changes to tax benefits

for education.

Employer-Provided Educational Assistance

The tax-free status of up to $5,250 of employer-provided educational assistance benefits each year for undergraduate-level

courses was scheduled to end for courses beginning after 2001.

This benefit has been extended indefinitely and, beginning in

2002, it also applies to graduate-level courses. For more information, see chapter 9 in Publication 970, Tax Benefits for

Higher Education.

Qualified Tuition Programs (QTPs)

Beginning in 2002, changes apply to what were formerly known

as qualified state tuition programs. For more complete information on QTPs, see chapter 6 in Publication 970. Also see lesson

16.

Name change. Qualified state tuition programs are renamed

qualified tuition programs (QTPs).

Distributions from state-maintained QTPs. A distribution

from a QTP established and maintained by a state (or an

agency or instrumentality of the state) can be excluded from

Important Changes and

Reminders for 2002 iii

IMPORTANT CHANGES AND

REMINDERS FOR 2002
iv Important Changes and

Reminders for 2002

income if the amount distributed is used for higher education.

Previously, the beneficiary was required to pay tax on any

earnings from a QTP unless the earnings were tax-free under

some other provision of the law.

QTPs maintained by educational institutions. You can

make contributions to a QTP established and maintained by

one or more eligible educational institutions. Any earnings distributed before January 1, 2004, will be taxable. Previously,

contributions could only be made to a QTP established and

maintained by a state (or an agency or instrumentality of the

state).

Rollovers of QTPs to family members. For purposes of

rollovers and changes of designated beneficiaries, the definition

of family members is expanded to include first cousins of the

beneficiary.

Rollovers of QTPs without changing the beneficiary.

Amounts in a QTP can be rolled over, tax free, to another QTP

set up for the same beneficiary. However, the rollover of credits

or other amounts from one QTP to another QTP for the benefit

of the same beneficiary cannot apply to more than one transfer

within any 12-month period.

Qualified expenses. Calculation of the amount that is considered reasonable for room and board expenses has been

changed. You must contact the educational institution for their

qualified room and board costs.

Special needs beneficiaries. The definition of “qualified

higher education expenses” has been expanded to include

expenses of a special needs beneficiary that are necessary for

that person’s enrollment or attendance at an eligible institution.

Coordination with Coverdell ESAs. You can make contributions to QTPs and Coverdell ESAs in the same year for the

same beneficiary. Previously, you could only make contributions

to one program or the other.

Coverdell ESAs

Beginning in 2002, the following changes apply to Coverdell

Education Savings Accounts (Coverdell ESAs). For more complete information on Coverdell ESAs, see chapter 5 in

Publication 970. Also see lesson 16.

Maximum contribution. The most you can contribute each

year to a Coverdell ESA is increased from $500 to $2,000.

Income limits. If you file a joint return, the amount you can

contribute to a Coverdell ESA will be phased out (gradually

reduced) if your modified adjusted gross income (MAGI) is more

than $190,000 but less than $220,000. You will not be able to
contribute to a Coverdell ESA if your MAGI is $220,000 or

more.

Contribution due dates. The final date on which you can

make contributions to a Coverdell ESA for any year has been

extended to the due date of your return for that year (not

including extensions). If you are a calendar year taxpayer, you

generally will have until April 15, 2003, to make your contribution for the 2002 tax year. In previous years, contributions were

required to be made by December 31.

Correcting excess contributions. The 6% excise tax on

excess contributions will not apply to any excess contributions

withdrawn by June 1 of the following year if the earnings on

the excess are also withdrawn. Previously, these amounts had

to be withdrawn by the due date for the beneficiary’s return or,

if no return was required, by April 15 of the following year.

Qualified expenses. The definition of qualified education

expenses has been expanded to include elementary and secondary education expenses. Qualified elementary and secondary education expenses include expenses for:

• Tuition, fees, academic tutoring, special needs services in 

the case of a special needs beneficiary, books, supplies, and 

other equipment incurred in connection with enrollment or 

attendance as an elementary or secondary school student at 

a public, private, or religious school,

•Room and board, uniforms, transportation, and supplementary items and services (including extended day programs) 

which are required or provided by a public, private, or religious school in connection with such enrollment or attendance, and

•The purchase of computer technology or equipment or 

Internet access and related services, if such technology, 

equipment, or services are to be used by the beneficiary and 

the beneficiary’s family during any of the years the beneficiary is in school (not including expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature).

Special needs beneficiaries. You can continue to make contributions to a Coverdell ESA for a special needs beneficiary

after his or her 18th birthday.

You can also leave assets in a Coverdell ESA set up for a

special needs beneficiary after the beneficiary reaches age 30.

Coordination with Hope and lifetime learning credits.

You can claim the Hope or lifetime learning credit in the same

year you take a tax-free distribution from a Coverdell ESA,

provided the distribution from the Coverdell ESA is not used

Important Changes and

Reminders for 2002 v
vi Important Changes and

Reminders for 2002

for the same expenses for which the credit is claimed.

Previously, you could not claim the Hope or lifetime learning

credit if you received a tax-free withdrawal from a Coverdell

ESA and did not waive the tax-free treatment of the withdrawal.

Coordination with qualified tuition programs (QTPs).

You can make contributions to Coverdell ESAs and qualified

tuition programs in the same year for the same beneficiary.

Previously, you could only make contributions to one program

or the other.

Tuition and Fees Deduction

(New Deduction for Higher Education Expenses)

Beginning in 2002, you may be able to deduct qualified tuition

and related expenses paid during the year for yourself, your

spouse, or a dependent, even if you do not itemize deductions

on Schedule A, Form 1040. See lesson 16.

Maximum deduction. For tax years beginning in 2002 and

2003, you may be able to deduct up to $3,000 you paid for qualified tuition and related expenses as an adjustment to income.

Coordination with credits and other deductions. You cannot deduct any amount for qualified tuition and related

expenses for a year if:

• A Hope credit or lifetime learning credit is claimed with 

respect to expenses of the individual for whom the tuition 

and related expenses were paid, or

• You can deduct the expense under any other provision of 

the law.

Coordination with exclusions. You must reduce your qualified tuition and related expenses by:

• Expenses you used to figure the amount of interest on qualified U.S. savings bonds that you excluded from income 

because you used it to pay qualified higher education 

expenses,

• Expenses you used to figure the amount of any tax-free 

withdrawals from a Coverdell ESA, and

• Expenses you used to figure the portion of any distribution 

of earnings from a qualified tuition program (QTP) you 

exclude from income because the earnings were used to pay

the beneficiary’s qualified higher education expenses.

Limits on eligibility. You cannot claim the deduction for qualified tuition and related expenses if any of the following apply.

• Another taxpayer is entitled to claim an exemption for you 

as a dependent on his or her return. This is true even if the
other taxpayer does not actually claim your exemption.

• Your filing status is married filing separate return.

• You are a nonresident alien and you have not elected to be 

treated as a resident alien for the tax year.

Year of deduction. Generally, you can deduct only those

expenses for a year that are in connection with enrollment at

an institution of higher education during the same year.

However, you can deduct expenses paid in a year if they

are for an academic period beginning within the year or during

the first three months of the next year.

Student name and ID number. To take the deduction, you

must show on your income tax return the name and taxpayer

identification number (usually the social security number) of

the person for whom the expenses were paid.

Student Loan Interest Deduction

If you pay interest on a student loan, you may be able to deduct

the interest as an adjustment to income. For more complete

information on the student loan interest deduction, see chapter

3 in Publication 970. Also see lesson 16.

Elimination of 60-month limit. Beginning in 2002, the

requirement that you can only deduct student loan interest

paid during the first 60 months that interest payments are

required is eliminated.

Limit on deduction based on modified adjusted gross

income. Beginning in 2002, the amount of your student loan

interest deduction will be phased out (gradually reduced) if

your modified adjusted gross income (MAGI) is between

$50,000 and $65,000 ($100,000 and $130,000 if you file a joint

return). You will not be able to take a student loan interest

deduction if you MAGI is $65,000 or more ($130,000 or more if

you file a joint return).

Modified Adjusted Gross Income (MAGI). Prior to 2002,

your MAGI for purposes of the student loan interest deduction

was your adjusted gross income as shown on your return modified by adding back any:

1) Foreign earned income exclusion,

2) Foreign housing exclusion or deduction,

3) Exclusion of income for bona fide residents of American 

Samoa, and

4) Exclusion of income from Puerto Rico.

Beginning in 2002, you must also add back any deduction of

qualified tuition and related expenses.

Important Changes and

Reminders for 2002 vii
viiiImportant Changes and

Reminders for 2002

Earned Income Credit

The following paragraphs explain the changes to the earned

income credit for 2002. The earned income credit is explained

in Publication 596, Earned Income Credit. Also see lesson 10.

New definition of earned income. The amount of earned

income credit you can claim is based, in part, on your taxable

earned income. For tax years after 2001, earned income will

no longer include nontaxable employee compensation.

Nontaxable employee compensation includes amounts such as

salary deferrals and reductions, excludable dependent care benefits, and excluded combat pay.

Elimination of modified adjusted gross income (MAGI).

For tax years after 2001, you will no longer need to figure

MAGI. Your earned income credit will be figured using your

AGI, not MAGI.

New rules for persons with same qualifying child.

Beginning with tax year 2002, if a child is a qualifying child of

more than one taxpayer, the taxpayers may choose which of

them will claim the credit on the basis of that child.

New definition of foster child. The definition of an eligible

foster child is changed. The child will have to live with you only

for more than half of the tax year. Previously, the child must

have lived with you the entire year.

Reduction of EIC by alternative minimum tax eliminated. Your earned income credit no longer is reduced by the

amount of alternative minimum tax shown on your return.

Photographs of Missing Children

The IRS is a proud partner with the National Center for

Missing and Exploited Children. Photographs of missing children selected by the Center may appear in this publication on

pages that would otherwise be blank. You can help bring these

children home by looking at the photographs and calling 1-800-

THE-LOST (1-800-843-5678) if you recognize a child.
Introduction ix

The Military Supplement to the Volunteer Assistor’s Guide

covers the special tax situations of active members of the U.S.

Armed Forces. It does not cover military pensions or veterans’

benefits. For information on military pensions and veterans’

benefits, see Publication 525, Taxable and Nontaxable Income.

For federal tax purposes, the U.S. Armed Forces includes commissioned officers and enlisted personnel in all regular and

reserve units under control of the Secretaries of Defense, Army,

Navy, and Air Force. The Armed Forces also includes the Coast

Guard. It does not include members of the U.S. Merchant

Marine or the American Red Cross.

Generally, tax laws apply to all citizens and residents of the

United States. However, some types of pay, exclusions, and other

provisions of law are of special interest to members of the Armed

Forces. Some lessons in this book apply material from the

Volunteer Assistor’s Guide to military situations. Other lessons

cover topics that are not mentioned in the Volunteer Assistor’s

Guide (such as alien issues and moving and travel expenses).

Use Lesson 3, Tax Benefits for Combat Zone Participants, when

looking for:

■ Information on the extension of deadline to file returns and

to take care of tax matters, and

■ Answers to questions about persons who die in a combat

zone or in a terrorist action.

Additional information for combat zone participants is included in

Lesson 1, Gross Income; Lesson 11, Sale of Home; and Lesson 15,

Filing Returns.

Read each lesson of this supplement carefully. When you are

ready, check your understanding by working the exercises without referring to the answers. Finally, check your answers in the

Answers to Exercises at the end of the lesson. If your answers

are not correct, reread the related sections.

INTRODUCTION
x Introduction

In addition to the material used with the regular VITA/TCE

course, such as Publication 17, Your Federal Income Tax, and

the instructions to Forms 1040, 1040A, and 1040EZ, other 

publications should be used with the military supplement.

These include:

Publication 3, Armed Forces’ Tax Guide

Publication 54, Tax Guide for U.S. Citizens and Resident

Aliens Abroad

Publication 463, Travel, Entertainment, Gift, and Car

Expenses

Publication 501, Exemptions, Standard Deduction, and

Filing Information

Publication 508, Tax Benefits for Work-Related Education

Publication 516, U.S. Government Civilian Employees

Stationed Abroad

Publication 519, U.S. Tax Guide for Aliens

Publication 521, Moving Expenses

Publication 523, Selling Your Home

Publication 553, Highlights of 2002 Tax Changes

Publication 555, Community Property

Publication 596, Earned Income Credit 

Publication 970, Tax Benefits for Education

Note: In figuring a deduction for contributions to an IRA, Armed

Forces members (including reservists on active duty for more

than 90 days) are considered active participants in an employermaintained retirement plan. See Lesson 17, IRAs/TSPs.

Individuals serving in the U.S. Armed Forces or in support of the

U.S. Armed Forces in designated combat zones have additional

time to make a qualified retirement contribution to an IRA. 

For more information on this extension of deadline provision,

see Lesson 3, Tax Benefits for Combat Zone Participants, in 

this supplement.

Members serving in a qualified hazardous duty area, designated

by statute, are afforded the same benefits as members serving

in a combat zone designated by Executive Order. In this 

publication, the term combat zone applies to both areas.
OBJECTIVES

At the end of this lesson, you will be able to:

1. Determine which items received by Armed Forces members

are includible in gross income.

2. Determine if an amended return must be filed for a taxpayer who received medical separation pay.

3. Determine who qualifies for exclusion of pay from income

because of service in a combat zone.

4. Identify qualifying items of military pay received for service

in a combat zone.

INTRODUCTION

This lesson discusses whether to include specific items in gross

income. You should be aware, however, that certain items

related to moving or travel expenses generally must be

accounted for even if they are not considered income. (See

Lessons 12 and 13)

This lesson includes information about the combat zone exclusion. For additional tax benefits, see Lesson 3, Tax Benefits for

Combat Zone Participants.

Note: For a quick reference, a glossary of military payroll

terms located at the end of this chapter defines types of military pay and allowances.

FORM W-2

Includible military income will generally be the amount shown

in box 1 of Form W-2, Wage and Tax Statement. If this amount

differs from the last Leave and Earnings Statement for 2002,

advise the person to contact his or her local accounting and

finance or payroll office for an explanation.

The wages shown in box 1 of the 2002 Form W-2 should not

include military pay excluded from an individual’s income

under the combat zone exclusion provisions. Tax exempt

earned income, basic allowance for subsistence (BAS), basic

allowance for housing (BAH), and certain in-kind allowances

are no longer reported in box 13 of Form W-2.

Lesson 1 1-1

GROSS INCOME

LESSON 1
1-2 Lesson 1

INCLUDIBLE INCOME

Members of the Armed Forces receive many different types of

pay and allowances. Some are includible in gross income while

others are excludable from gross income. Includible items are

subject to tax and must be reported on the taxpayer’s tax

return. Excludable items are not subject to tax, but may have

to be shown on the tax return. The following items are includible in gross income, unless the pay is for service in a combat

zone declared by an executive order of the President or in a

qualified hazardous duty area declared by statute:

Accrued Leave Payment Aviation Career Incentive Pay

Basic Pay Continuation Pay

Diving Pay Enlistment Bonus *

Flight Duty Pay Foreign Duty Pay

Hostile Fire Pay Imminent Danger Pay

Medical/Dental Officer Pay Medical Separation Pay

Nuclear Qualified Officer Pay Overseas Extension Bonus

Personal Money Allowance Proficiency Pay

Reenlistment Bonus * Responsibility Pay

Scholarships (AFHPSP) Sea Duty Pay

Separation Pay Student Loan Repayments

Veterinary Officer Pay

* Enlistment and reenlistment bonuses fall under the category

of taxable income. Income tax will be deducted from these entitlements before they are paid to the service member. Income

tax is withheld at a flat rate of 27% as bonuses are treated as

supplemental wages. Service member will not need to account

for enlistment and reenlistment bonuses separately when

preparing their tax returns as the payments and withholdings

will be reflected on their W-2 form. If a service member feels

this information is incorrect they will need to contact their local

accounting and finance or payroll office.

A reenlistment bonus may be tax free if the voluntary extension or reenlistment occurs in a month the service member

served in a combat zone.
EXCLUDABLE INCOME

The following qualified military benefits do not have to be

reported as income on Form 1040, 1040A, or 1040EZ. The exclusion applies whether the item is furnished in kind or is a reimbursement or allowance. The personal use of a vehicle cannot be

excluded from gross income as a qualified military benefit.

Basic Allowance for Basic Allowance for Subsistence

Housing (BAH) (BAS)

Combat Zone Compensation Congressional Medal of

(including hostile fire pay Honor Pension

or imminent danger pay)

(limited amount for officers)

Death Allowances Defense Counseling

Dislocation Allowances Evacuation Allowance

Family Allowances Group-term Life Insurance

Interment Allowance Medical Benefits

Moving and Storage Other Quarters Allowances

Overseas Housing Per Diem (Including reservist)

Allowance (OHA)

Professional Education Qualified Hazardous

Duty Pay

ROTC Educational and Survivor and Retirement

Subsistence Allowances Protection Plan Premiums

Deducted from Military

Retired Pay

Trailer Allowance Veterans’ Benefits

Note: If the person you are helping is a member of the Armed

Forces and was provided a commuter highway vehicle (such 

as a van) by his or her employer in 2002, refer the taxpayer 

to Publication 525, Taxable and Nontaxable Income, and to a

paid professional preparer.

MEDICAL SEPARATION PAY

Service members who have been separated for medical reasons

are given severance pay, which is included in the W-2 Form and

is taxable as wages. The Veteran’s Administration then determines the amount of the medical disability pension due. The

service member does not receive the pension until the severance pay amount is offset.

Lesson 1 1-3
1-4 Lesson 1

Disability compensation is a monetary benefit paid to veterans

who are disabled by injury or disease incurred or aggravated

during active military service. The service of the veteran must

have been terminated through separation or discharge under

conditions that were other than dishonorable. Disability compensation varies with the degree of disability and the number

of dependents, and is paid monthly. The benefits are not subject

to federal or state income tax. The payment of military retirement pay, disability severance pay and separation incentive

payments known as SSB and VSI (Special Separation Benefits

and Voluntary Separation Incentives) also affects the amount of

VA compensation paid. 

Example

Anita Bennett, an active duty service member, was separated

due to a medical condition. At the time of her separation she

was given medical separation pay or severance pay in the

amount of $16,000.00. The severance pay was subject to 27%

withholding and she received $11,520. The withholding

amount of $4,320 was included on her W-2 Form. The next

year the Veteran’s Administration (VA) determined that due to

her medical condition she was entitled to a VA disability pension of $1,000,00 per month from the date of her discharge.

However, the VA will not pay her disability pension until the

severance pay has been offset. In this case, 16 months after

her discharge. At the time she receives her determination letter from the VA, the tax return that includes her severance pay

should be amended to exclude the $16,000.00 severance pay

and designate that pay as “disability pay included in wages”.

COMBAT ZONE EXCLUSION

Members of the U.S. Armed Forces who serve in a combat zone

(defined later) may exclude certain pay from their income. They

do not have to receive the pay while in a combat zone, in a hospital, or in the same year they served in a combat zone.

However, the entitlement to the pay must have fully accrued in

a month during which they served in the combat zone or were

hospitalized as a result of wounds, disease, or injury incurred

while serving in the combat zone. The following military pay

can be excluded from their income.

• Active duty pay earned in any month during which they

served in a combat zone.

• Imminent danger/hostile fire pay

• A reenlistment bonus if the voluntary extension or reenlistment occurs in a month during which they served in a combat zone.

LESSON 1
• Pay for accrued leave earned in any month during which they

served in a combat zone. The Department of Defense must

determine that the unused leave was earned during that

period.

• Pay received for duties as a member of the Armed Forces in

clubs, messes, post and station theaters, and other nonappropriated fund activities. The pay must be earned in a month

during which they served in a combat zone.

• Awards for suggestions, inventions, or scientific achievements

to which members are entitled to because of a submission

they made in a month during which they served in a combat

zone.

• Student loan repayments that are attributable to their period

of service in a combat zone.

Retirement pay does not qualify for the combat zone exclusion.

Partial (month) service. Members of the U.S. Armed Forces

who serve in a combat zone for one or more days during a particular month, are entitled to an exclusion for that entire

month.

Combat Zone

A combat zone is any area the President of the United States

designates by Executive Order as an area in which the U.S.

Armed Forces are engaging or have engaged in combat. An

area usually becomes a combat zone and ceases to be a combat

zone on the dates the President designates by Executive Order.

Afghanistan area. By Executive Order No. 13239,

Afghanistan (and airspace above) is designated as a combat

zone beginning September 19, 2001.

Yemen area. Executive Order No. 13239 was extended to

include Yemen as a designated combat zone beginning April

10, 2002.

The Kosovo area. By Executive Order No. 13119 and Public

Law 106-21, the following locations (including air space above)

were designated as a combat zone and a qualified hazardous

duty area beginning March 24, 1999.

• Federal Republic of Yugoslavia (Serbia/Montenegro)

• Albania

• The Adriatic Sea 

• The Ionian Sea—north of the 39th parallel (including all of

the airspace in connection with the Kosovo operation.) 

Lesson 1 1-5
1-6 Lesson 1

Persian Gulf area. By Executive Order No. 12744, the following locations (and airspace above) were designated as a combat

zone beginning January 17, 1991.

• The Persian Gulf,

• The Red Sea,

• The Gulf of Oman,

• The part of the Arabian Sea that is north of 10 degrees north

latitude and west of 68 degrees east longitude,

• The Gulf of Aden, and 

• The total land areas of Iraq, Kuwait, Saudi Arabia, Oman,

Bahrain, Qatar, and the United Arab Emirates.

Qualified hazardous duty area. Beginning November 21,

1995, a qualified hazardous duty area in the former Yugoslavia

is treated as if it were a combat zone. The qualified hazardous

duty area includes:

• Bosnia and Herzegovina,

• Croatia, and

• Macedonia.

Members of the Armed Forces deployed overseas away from

their permanent duty station in support of operations in a qualified hazardous duty area, or performing qualifying service outside the qualified hazardous duty area, are treated as if they

are in a combat zone solely for the purposes of the extension of

deadlines discussed in Lesson 3. These personnel are not entitled to other combat zone tax benefits.

Serving in a Combat Zone

Service in a combat zone includes any periods that military

members are absent from duty because of sickness, wounds, or

leave. If, as a result of serving in a combat zone, a person

becomes a prisoner of war or is missing in action, that person is

considered to be serving in the combat zone so long as he or she

keeps that status for military pay purposes. 

Qualifying service outside combat zone. Military service

outside a combat zone is considered to be performed in a combat zone if:

• The service is in direct support of military operations in the

combat zone, and

• The service qualifies a member for special military pay for

duty subject to hostile fire or imminent danger. 
Military pay received for this service will qualify for the combat

zone exclusion if the other requirements are met.

Non-qualifying presence in combat zone. The following military service does not qualify as service in a combat zone.

• Presence in a combat zone while on leave from a duty station

located outside the combat zone,

• Passage over or through a combat zone during a trip between

2 points that are outside a combat zone, and

• Presence in a combat zone solely for a member’s personal

convenience.

Note. Military Members are considered to be serving in a combat zone if they are either assigned on official temporary duty

to a combat zone or they qualify for hostile fire/imminent danger pay while in a combat zone.

Amount of Exclusion

Enlisted members. Enlisted members, warrant officers, or

commissioned warrant officers who serve in a combat zone during any part of a month, can exclude all of their military pay

for that month from their income. They can also exclude military pay earned while they are hospitalized as a result of

wounds, disease, or injury incurred in the combat zone. The

exclusion of their military pay while they are hospitalized does

not apply to any month that begins more than 2 years after the

end of combat activities in that combat zone. Their hospitalization does not have to be in the combat zone.

Officers. Commissioned officers (including Limited Duty

Officers), may exclude their pay according to the rules just discussed. However, the amount of their exclusion is limited to the

highest rate of enlisted pay (plus imminent danger/hostile fire

pay they received) for each month during any part of which

they served in a combat zone or were hospitalized as a result of

their service there.

Hospitalized while serving in the combat zone. If a

member is hospitalized while serving in the combat zone, the

wound, disease, or injury causing the hospitalization will be

presumed to have been incurred while serving in the combat

zone unless there is clear evidence to the contrary.

Example

Ron Brady is hospitalized for a specific disease after serving in

a combat zone for 3 weeks, and the disease for which he is hospitalized has an incubation period of 2 to 4 weeks. The disease

is presumed to have been incurred while he was serving in the

Lesson 1 1-7

LESSON 1
1-8 Lesson 1

combat zone. On the other hand, if the incubation period of the

disease were one year, the disease would not have been

incurred while he was serving in the combat zone. 

Hospitalized after leaving the combat zone. In some cases

the wound, disease, or injury may have been incurred while

serving in the combat zone, even though the member was not

hospitalized until after he/she left.

Example

Martha Mason was hospitalized for a specific disease 3 weeks

after she left the combat zone. The incubation period of the

disease is from 2 to 4 weeks. The disease was considered

incurred while serving in the combat zone.

COMMUNITY PROPERTY

The community property states are Arizona, California, Idaho,

Louisiana, Nevada, New Mexico, Texas, Washington, and

Wisconsin. Special rules apply to married persons who file separate returns or who were divorced during the tax year and

were domiciled in a community property state.

For military personnel in community property states, the key

word is “domicile.” Domicile describes someone’s legal, permanent residence. It is not always where the person presently

lives.

Whether an item is subject to community property laws

depends on the nature of the payment.

Armed Forces pay. State community property laws apply to

active military pay. Generally, the character of the pay as separate to community income is determined by the marital status

and domicile of the Armed Forces member and his or her

spouse while the member is in active military service.

Armed Forces retired or retainer pay. Retired or retainer

payments to a member of the Armed Forces may be subject to

community property laws.

For more information, see Publication 555, Community Property.
Lesson 1 1-9

Exercise 1

Which of the following should be included in gross income?

A. Basic Allowance for Subsistence (BAS)

B. Overseas Housing Allowance

C. Lump sum for accrued leave, paid on separation

D. Foreign language proficiency pay

E. Uniform allowance

F. Foreign duty pay

G. Reenlistment Bonus received while a service member was 

deployed to Qatar

H. Hazardous duty pay

I. Family Separation Allowance received while a service

member was deployed to Italy

Answer ____________________________________________

Exercise 2

Sergeant James Walker was medically separated, in November

2001, from active duty military service due to a medical condition that interfered with his ability to perform his military

duties. James was entitled to and received $12,000 in medical

separation pay. After taxes he received $8,640. Prior to his

separation he submitted the required documentation to the

Veteran’s Administration applying for disability pay. James

filed his tax return in March 2002 and received a $567 refund.

In August of 2002 James received his determination letter from

VA informing him he was entitled to an $800 disability pension

per month from the date of his discharge.

A. Does James need to file an amended tax return?

Answer ____________________________________________

B. What amount of pay will James need to exclude from his 

pay when he files an amended tax return?

Answer ____________________________________________

C. When will James start receiving his disability pension?

Answer ____________________________________________
1-10 Lesson 1

 SUMMING UP THIS LESSON 

You have learned that certain items received by members of

the Armed Forces are included in their gross income. Certain

other items are specifically excluded by law. Pay for service in

a combat zone is not taxed for an enlisted member of the U.S.

military. The amount of income t hat is not taxed for commissioned officers serving in a combat zone is limited to the highest rate of enlisted pay plus the amount of imminent danger

pay per month.
Lesson 1 1-11

Exercise 1 C, D, F, and H

Exercise 2 A – Yes

B – $12,000

C – 15 months or March of 2003

GROSS INCOME ANSWERS TO EXERCISES

LESSON 1
1-12 Lesson 1

LEGEND

I – Includible

X – Excludable

GLOSSARY OF MILITARY PAYROLL TERMS

Term Definition

I Accrued Leave Payment Lump sum paid for unused

accrued leave when term of

service expires

I Aviation Career Incentive pay for Aviation

Incentive Pay officers

X Basic Allowance for Paid to members of the Armed 

Housing (BAH) Forces for housing

X Basic Allowance for Paid for subsistence including

Subsistence (BAS) rations furnished in-kind to

enlisted members 

I Basic Pay Pay for active duty

X Combat Zone Pay received for service in a 

Exclusion (pay combat zone as designated by

excludable up to the Executive Order (see previous

highest rate of enlisted discussion under “Combat Zone

pay per month for Exclusion”)

commissioned officers)

I Continuation Pay Paid to certain personnel who

extend their active duty period

X Death Allowances Death gratuity payments 

(up to $3,000) made to eligible

survivors and payments for

burial services and travel of

dependents to burial site

X Defense Counseling Provided by the Armed Forces

to represent military personnel

in their defense before a general or special court-martial or

at an investigation or in a 

foreign criminal proceeding

X Discharge Gratuity Payments of not more than

$25, received if other than 

honorable discharge

X Dislocation Allowances Payments to defray extra costs

of moving from a permanent

duty station

I Diving Pay Pay for diving operations

I Enlistment Bonus Payable to certain “criticalskilled” enlistees upon entering

the Service

X Evacuation Allowance Paid to offset expenses for

dependents who must leave for

a place of safety

X Family Allowances Paid when military families

are separated due to overseas

assignments, for emergencies,

and for certain educational

expenses for dependents
Lesson 1 1-13

I Flight Duty Pay Monthly pay supplement for

flight time

I Foreign Duty Pay Paid to enlisted personnel 

serving outside the 48 contiguous states and the District of

Columbia

X Group-term Life Insurance Military life insurance

I Hostile Fire Pay Pay for hazardous duty

(exceptions may apply 

when earned in a 

combat zone)

I Imminent Danger Pay Pay for duty in an area in 

(exceptions may apply which member is exposed

when earned in a combat to hostile fire or imminent

zone) danger

X Interment Allowance Burial and death allowances

X Medal of Honor Pension Pension for Congressional 

Medal of Honor holders

I Medical and Dental Pay given to certain medical

Officers Pay and dental officers

X Medical Benefits Free medical services and medical insurance

X Moving and Storage In-kind transportation, storage

of household goods, and travel

allowances

I Nuclear Qualified Pay to certain nuclear naval

Officer Pay officers

X Other Quarters Paid because of inadequate

Allowances quarters or housing and cost of

living allowances abroad

(whether paid by the U.S.

Government or by a foreign

government)

I Overseas Extension Bonus Paid to certain enlisted 

personnel upon extending their

overseas tour

X Per Diem An amount paid in place of

subsistence and mileage when

away from permanent duty

stations

Permanent Post of The duty station where the

Duty (POD) military personnel is assigned

by permanent orders

I Personal Money Pay to high-ranking officers to

Allowance defray expenses incurred in

their official positions

X Professional Education Education costs paid by the

U.S. Government for Armed

Forces personnel
1-14 Lesson 1

I Proficiency Pay Awards to enlisted personnel

who show special proficiency in

a military skill

X Qualified Hazardous Exclusion of all military pay

Duty Pay per month for enlisted personnel and warrant officers, limited to maximum enlisted rate

plus imminent danger pay for

officers

I Reenlistment Bonus Multiple of monthly basic 

pay times additional years of

re-enlistment service

I Responsibility Pay Earned in certain pay grades

by officers serving in a position

of unusual responsibility or

critical nature

X ROTC Educational and Paid for education and 

Subsistence Allowances subsistence

I Sea Duty Pay Paid for duty on a vessel under

orders of a competent authority

operating outside the contiguous United States

I Separation Pay Lump-sum payment paid upon

involuntary discharge or

release in certain cases

I Student Loan Repayment Repayments from programs

such as the Department of

Defense Educational Loan

Repayment Program

X Survivor and Retirement Premiums taken from the

Protection Plan Premium gross pay of retired personnel

of the Armed Forces to provide

a survivor annuity

X Trailer Allowance Pay for moving a trailer from a

permanent POD

X Uniforms Uniforms furnished enlisted

(In Kind or Allowances) personnel and allowances paid

to officers

X Overseas Housing Paid to personnel living in a 

Allowance high cost of living area outside 

the continental U.S. (except 

Hawaii and Alaska)

X Veterans’ Benefits Benefits administered by the

Department of Veterans

Affairs, generally based on a

combat-related disability

I Veterinary Officer Pay Pay given to certain Veterinary

Corps Officers
Lesson 2 2-1

OBJECTIVES

At the end of this lesson you will be able to:

1. Determine whether the taxpayer qualifies for the foreign

earned income exclusion.

2. Calculate the foreign earned income exclusion.

INTRODUCTION

In this lesson, we will discuss the foreign earned income

exclusion. Certain taxpayers can exclude income earned in

foreign countries. For 2002, the maximum exclusion amount is

$80,000. However, the foreign earned income exclusion does

not apply to wages and salaries of military and civilian

employees of the U.S. Government. Employees of the U.S.

Government, include those who work at Armed Forces post

exchanges, officers’ and enlisted personnel clubs, and embassy

commissaries. Other foreign income earned by military personnel or their spouses may be eligible for the exclusion.

To qualify for the foreign earned income exclusion, the taxpayer’s tax home must be in a foreign country throughout your

period of stay. This lesson will explain this requirement.

REQUIREMENTS

There are two requirements to qualify for the foreign earned

income exclusion. First, the taxpayer must show that his or

her tax home is in a foreign country. (“Foreign country” does

not include Puerto Rico, Guam, the Northern Mariana Islands,

the Virgin Islands, or U.S. possessions such as America Samoa,

Wake Island, the Midway Islands and Johnston Island.) The

second requirement is that the taxpayer must meet either the

bona fide residence test or the physical presence test.

FOREIGN EARNED

INCOME EXCLUSION

LESSON 2
2-2 Lesson 2

Exercise 1

Miranda has lived in Puerto Rico since 1998. Is she eligible for

the foreign earned income exclusion?

Answer __________________________________________

The requirements are applied separately to each individual. If

a husband and wife are each working overseas, each must meet

both requirements, to apply the exclusion. If they do so, each is

entitled to an exclusion of up to $80,000 (on qualified income)

for 2002. (Remember military pay is not eligible for the

exclusion.)

Tax Home. To claim the foreign earned income exclusion, the

taxpayer’s home must be in a foreign country. Generally, one’s

tax home is the area of the taxpayer’s main place of business,

employment or post of duty, regardless of where the taxpayer

maintains his or her family home.

The tax home for military personnel is the permanent duty station, either land based or on a ship. This is true whether it is

feasible or permissible for the taxpayer’s family to live with

him or her. Generally, therefore most military personnel

and their dependents will not qualify for the Foreign

Earned Income exclusion.

Example 1

John and Mary are both in the armed forces and have been

permanently stationed in Germany since August 2001. Their

tax home for 2002 would be Germany.

Exercise 2

Alan has lived and worked in China since August 16, 1999.

For 2002, what country is his tax home?

Answer __________________________________________

If the taxpayer does not have a regular or main place of business because of the nature of the work, then the tax home is

the place where the taxpayer regularly lives.

When the taxpayer has a tax home in the U.S. and goes overseas temporarily, or on business, the tax home has not changed.

If the taxpayer is assigned overseas on business for an indefinite period, the tax home is overseas and the taxpayer may be

eligible for the foreign earned income exclusion.
Example 2

Henry is in the Armed Forces. He was assigned to a post in

Japan in 2002. This assignment was for an indefinite period.

Margaret, his wife, accompanied him to Japan and has foreign

earned income. Their tax home for 2002 would be Japan.

Period of Stay. Another qualification for the exclusion is the

length of time the taxpayer stays overseas. This requirement

can be satisfied in one of two ways. The taxpayer must be:

1. A U.S. citizen or resident alien from a tax treaty country who

is a bona fide resident of a foreign country (or countries)

for an uninterrupted period that includes an entire tax year,

or

2. A U.S. citizen or U.S. resident alien who is physically present in a foreign country or countries for at least 330 full

days during any period of 12 consecutive months.

Exercise 3

Jennifer is a U.S. citizen who has lived in Israel since October

1, 2002. She expects to return to the U.S. in May, 2003. Does

she meet either period of stay test?

Answer __________________________________________

Bona Fide Resident Test. To meet the test, the taxpayer

must show that he or she has set up permanent quarters in a

foreign country. The period must be for an uninterrupted period

that includes an entire tax year. Taking a brief trip to the U.S.

will not prevent the taxpayer from being a bona fide resident,

as long as the intention is clear to return to the foreign country.

Example 3

Jane is a military spouse who has lived in England since 1999.

Her mother still lives in the U.S. Jane came to the U.S. for two

weeks in 2002 to be with her mother after she had surgery.

Jane’s trip to the U.S. does not affect her status as a bona fide

resident of a foreign country.

Physical Presence Test. The other test that may be met

instead of the bona fide residence test is the physical presence

test. To qualify, the taxpayer must be physically present in a

foreign country 330 full days during a period of twelve consecutive months. 

Lesson 2 2-3
2-4 Lesson 2

Exercise 4

Shauntell is using the twelve months of 2002 to determine if

she qualifies for the physical presence test. She arrived in

Kenya on January 3, 2002 and worked there until August 12,

2002 when she returned to the U.S. for 6 weeks. On October 1,

2002 she returned to Kenya and worked there until she

permanently returned to the U.S. on January 1, 2003. Does

she meet the physical presence test for 2002?

Answer __________________________________________

Waiver of Time Requirements. The minimum time requirements for period of stay may be waived, if the taxpayer is

forced to leave a foreign country because of war, civil unrest, or

similar adverse conditions in that country. The taxpayer must

show that he/she could have met the minimum time requirements if it had not been for the adverse conditions. 

QUALIFYING INCOME

To qualify for the exclusion, income must be earned income.

Examples of earned income are salaries, wages, commissions

and professional fees. Earned income does not include dividends, interest, capital gains, alimony, social security benefits,

pensions or annuities. To qualify for the exclusion, the earned

income must be for services (other than military or U.S. government) performed in a foreign country. 

Amounts paid by the United States or its agencies to its

employees do not qualify for the exclusion. This includes military pay and payment for such activities as post exchanges,

commissaries, and officers clubs.

Example 4

Maria, a U.S. resident, is in the armed forces and has lived in

Lisbon since 1999. Her military pay is not eligible for the foreign earned income exclusion. In her spare time, she is a selfemployed DJ in Lisbon and the surrounding area. The income

from her self-employment may qualify for the exclusion.

LESSON 1
Exercise 5

Maurice is stationed in Germany. His only income is from his

U.S. military salary. Does he qualify for the foreign earned

income exclusion?

Answer __________________________________________

Exercise 6

Juanita lives in Scotland. She is retired and her income

consists of U.S. Social Security, a pension and several stock

dividends. Does she qualify for the foreign earned income

exclusion?

Answer __________________________________________

Exercise 7

Jose and Kim live in a foreign country. Jose has wages from

the U.S. military. Kim has wages from a bank that she works

at in the foreign country. Do they have qualifying income for

the foreign earned income exclusion?

Answer __________________________________________

CHOOSING THE EXCLUSION

The foreign earned income exclusion is voluntary. (There are

times when it may be to the taxpayer’s advantage to not claim

the exclusion.) The initial choice of the exclusion on Form 2555

or Form 2555EZ must be filed with a timely return (including

extensions). Exceptions do apply that allow the initial choice to

be made after a return is filed. Taxpayers who wish to take

advantage of these exceptions should seek professional tax

assistance.

The taxpayer may revoke the election for any tax year. When

the exclusion is revoked, the taxpayer may not claim the exclusion again for the next five tax years without the approval of

the IRS.

Lesson 2 2-5
2-6 Lesson 2

FORM 2555 OR FORM 2555EZ

If the taxpayer is qualified to, and wishes to claim the foreign

earned income exclusion, it is necessary to complete Form 2555

or 2555EZ and attach it to Form 1040. The tax return should

be filed with Internal Revenue Service Processing Campus,

Philadelphia, PA, 19255.

To be able to use Form 2555EZ, the taxpayer must be a U.S.

citizen or resident alien who has wages and salaries, but not

self-employment income. The total foreign earned income must

be $80,000 or less, and the person cannot be claiming any business or moving expenses. Taxpayers, who do not meet these

restrictions, should file Form 2555 to claim the credit.

Example 5

Michael and his wife Melissa have been stationed in Hong

Kong since 2001. Michael is employed by the armed forces.

Melissa operates a home day care business. Their tax home is

Hong Kong. They meet the physical presence test. Melissa

wants to exclude her self-employment income from U.S. taxation. She will need to complete Form 2555 instead of Form

2555EZ, because her income is from self-employment.

Exercise 8

Assuming that the following taxpayers meet the period of stay

test, should they file a Form 2555, or Form 2555EZ?

a. Mallory has $34,000 of foreign earned income. She has no 

other income. Which form should she file?

Answer __________________________________________

b. Jacob has U.S. military wages and self-employment income 

he earned in a foreign country. Which form should he file?

Answer __________________________________________

c. Ramie has $86,000 of foreign earned income. Which form 

should he file?

Answer __________________________________________

Taxpayers, who are eligible to file Form 2555EZ, should complete all four sections of the form.

On the following two pages, you will find a blank copy of Form

2555EZ for your reference.
Lesson 2 2-7

Draft as of

5/15/2002

General Information

OMB No. 1545-1326

Foreign Earned Income Exclusion Form 2555-EZ

Department of the Treasury

Internal Revenue Service  See separate instructions.  Attach to Form 1040.

Name shown on Form 1040 Your social security number

Your foreign address (including country) Your occupation

Employer’s name

For Paperwork Reduction Act Notice, see page 3 of separate instructions. Cat. No. 13272W Form 2555-EZ (2002)

4 5

6

9 Employer is (check any that apply):

A U.S. business

A foreign business

Other (specify) 

10a

If you answered “Yes,” enter the tax year for which the revocation was effective. 

b Of what country are you a citizen/national? 

Have you ever revoked the foreign earned income exclusion? Yes No

7 Employer’s U.S. address (including ZIP code) 8 Employer’s foreign address

● Are a U.S. citizen or a resident alien.

● Earned wages/salaries in a foreign country.

● Had total foreign earned income of

$80,000 or less.

● Do not have self-employment income.

● Do not have business/moving expenses. And You:

You May Use

This Form

If You:

b

c

a

b

c

● Do not claim the foreign housing

exclusion or deduction.

Part II

● Are filing a calendar year return that

covers a 12-month period.

11a List your tax home(s) during 2002 and date(s) established. 

If you filed Form 2555 or 2555-EZ after 1981, enter the last year you filed the form. 

If you did not file Form 2555 or 2555-EZ after 1981, check here  and go to line 11a now.

d

1 Bona Fide Residence Test

Yes No

Enter the date your bona fide residence began  , and ended (see instructions)  .

2 Physical Presence Test

Yes No

b

a

b

a

Tests To See If You Can Take the Foreign Earned Income Exclusion

Were you a bona fide resident of a foreign country or countries for a period that includes an entire tax year

(see page 2 of the instructions)?

Were you physically present in a foreign country or countries for at least 330 full days during—

● If you answered “Yes,” you meet this test. Fill in line 1b and then go to line 3.

● If you answered “No,” you do not meet this test. Go to line 2 to see if you meet the Physical Presence Test.

2002 or

any other period of 12 months in a row starting or ending in 2002?

● If you answered “Yes,” you meet this test. Fill in line 2b and then go to line 3.

● If you answered “No,” you do not meet this test. You cannot take the exclusion unless you meet the

Bona Fide Residence Test above.

The physical presence test is based on the 12-month period from  

● If you answered “No,” you cannot take the exclusion. Do not file this form.

Tax Home Test. Was your tax home in a foreign country or countries throughout your period of bona fide

residence or physical presence, whichever applies?

 

through  .

3

Yes No

● If you answered “Yes,” you can take the exclusion. Complete Part II below and then go to page 2.

Part I

Attachment

(99) Sequence No. 34A

2002
2-8 Lesson 2

Draft as of

5/15/2002

Form 2555-EZ (2002) Page 2

$80,000 00

Enter the number of days in your qualifying period that fall within 2002

Did you enter 365 on line 14?

Multiply line 13 by line 15

 .

Enter, in U.S. dollars, the total foreign earned income you earned and received in 2002 (see

instructions). Be sure to include this amount on Form 1040, line 7

Foreign earned income exclusion. Enter the smaller of line 16 or line 17 here and in

parentheses on Form 1040, line 21. Next to the amount enter “2555-EZ.” On Form 1040, subtract

this amount from your income to arrive at total income on Form 1040, line 22 

18

13

14

15

16

17

Maximum foreign earned income exclusion 13

14

15

17

18

16

Part IV Figure Your Foreign Earned Income Exclusion

Enter “1.000.”

Part III

(d) Income earned in U.S. 

on business (attach computation)

(c) Number of days

in U.S. on business (a) Date arrived in U.S. (b) Date left U.S.

Days Present in the United States—Complete this part if you were in the

United States or its possessions during 2002.

12

Divide line 14 by 365 and enter the result as

a decimal (rounded to at least three places).

Yes.

No.

days

Form 2555-EZ (2002)
Lesson 2 2-9

For those who must file Form 2555, the first section of the form

is for general information, and must be completed by all taxpayers who claim the exclusion.

Taxpayers who claim the bona fide residence test must complete Part II of Form 2555. Taxpayers who qualify under the

physical presence test must complete Part III.

Part IV of Form 2555 is completed by all taxpayers. This is the

section where the foreign earned income is listed. Do not list

military wages in this section; they are not considered foreign

earned income.

Page 3 of the form is where the exclusion is computed.

Generally, armed forces personnel and their spouses will not

qualify for the housing exclusion (the housing allowance is

already considered non-taxable income).

On the following three pages, you will find a blank Form 2555

for your reference.
2-10 Lesson 2

Draft as of

5/14/2002

OMB No. 1545-0067

Form 2555 Foreign Earned Income

Department of the Treasury

Internal Revenue Service

 See separate instructions.  Attach to Form 1040.

For Use by U.S. Citizens and Resident Aliens Only

Name shown on Form 1040 Your social security number

Your foreign address (including country) Your occupation

Employer’s name 

Employer’s U.S. address 

Employer’s foreign address 

Employer is (check

any that apply):

A foreign entity A U.S. company

Other (specify) 

Self

A foreign affiliate of a U.S. company

If, after 1981, you filed Form 2555 to claim either of the exclusions or Form 2555-EZ to claim the foreign earned income

exclusion, enter the last year you filed the form. 

Have you ever revoked either of the exclusions? Yes No

If you answered “Yes,” enter the type of exclusion and the tax year for which the revocation was effective. 

Did you maintain a separate foreign residence for your family because of adverse living conditions at your

tax home? See Second foreign household on page 3 of the instructions

If “Yes,” enter city and country of the separate foreign residence. Also, enter the number of days during your tax year that

you maintained a second household at that address. 

List your tax home(s) during your tax year and date(s) established. 

Next, complete either Part II or Part III. If an item does not apply, enter “NA.” If you do not give

the information asked for, any exclusion or deduction you claim may be disallowed.

Taxpayers Qualifying Under Bona Fide Residence Test (See page 2 of the instructions.)

10 Date bona fide residence began  , and ended 

11 Kind of living quarters in foreign country  Purchased house Rented house or apartment Rented room

Quarters furnished by employer

12a Did any of your family live with you abroad during any part of the tax year?

If “Yes,” who and for what period? 

Have you submitted a statement to the authorities of the foreign country where you claim bona fide residence

that you are not a resident of that country? (See instructions.)

13a

b Are you required to pay income tax to the country where you claim bona fide residence? (See instructions.)

If you answered “Yes” to 13a and “No” to 13b, you do not qualify as a bona fide resident. Do not complete the rest of

this part.

If you were present in the United States or its possessions during the tax year, complete columns (a)–(d) below. Do not

include the income from column (d) in Part IV, but report it on Form 1040.

14

(d) Income earned in

U.S. on business

(attach computation)

(c) Number of

days in U.S.

on business

(d) Income earned in

U.S. on business

(attach computation)

(c) Number of

days in U.S.

on business

(b) Date left

U.S.

(a) Date

arrived in U.S.

(b) Date left

U.S.

(a) Date

arrived in U.S.

15a List any contractual terms or other conditions relating to the length of your employment abroad. 

b Enter the type of visa under which you entered the foreign country. 

c Did your visa limit the length of your stay or employment in a foreign country? If “Yes,” attach explanation

Did you maintain a home in the United States while living abroad?

e If “Yes,” enter address of your home, whether it was rented, the names of the occupants, and their relationship

to you. 

For Paperwork Reduction Act Notice, see page 4 of separate instructions. Cat. No. 11900P Form 2555 (2002)

Yes No

Yes No

Yes No

Yes No

Yes No

Yes No



3

4a

5

6a

c

8a

9

7

1 2

b

a

d

b

e

c

b

a

d

b c

d

d

b

Part I

Part II

General Information

b If you did not file Form 2555 or 2555-EZ after 1981 to claim either of the exclusions, check here  and go to line 7.

Of what country are you a citizen/national? 

Attachment

(99) Sequence No. 34

2002
Lesson 2 2-11

Draft as of

5/14/2002

Form 2555 (2002) Page 2

Taxpayers Qualifying Under Physical Presence Test (See page 2 of the instructions.)

16 The physical presence test is based on the 12-month period from  through 

17 Enter your principal country of employment during your tax year. 

If you traveled abroad during the 12-month period entered on line 16, complete columns (a)–(f) below. Exclude travel between

foreign countries that did not involve travel on or over international waters, or in or over the United States, for 24 hours or

more. If you have no travel to report during the period, enter “Physically present in a foreign country or countries for the entire

12-month period.” Do not include the income from column (f) below in Part IV, but report it on Form 1040.

18

(f) Income earned in U.S.

on business (attach

computation)

(e) Number of

days in U.S.

on business

(d) Full days

present in

country

(a) Name of country

(including U.S.) (b) Date arrived (c) Date left

All Taxpayers

Note: Enter on lines 19 through 23 all income, including noncash income, you earned and actually or constructively received during

your 2002 tax year for services you performed in a foreign country. If any of the foreign earned income received this tax year

was earned in a prior tax year, or will be earned in a later tax year (such as a bonus), see the instructions. Do not include

income from line 14, column (d), or line 18, column (f). Report amounts in U.S. dollars, using the exchange rates in effect

when you actually or constructively received the income.

If you are a cash basis taxpayer, report on Form 1040 all income you received in 2002, no matter when you performed

the service.

Amount 2002 Foreign Earned Income (in U.S. dollars)

19 Total wages, salaries, bonuses, commissions, etc. 19

20 Allowable share of income for personal services performed (see instructions):

a In a business (including farming) or profession 20a

b In a partnership. List partnership’s name and address and type of income. 

20b

21 Noncash income (market value of property or facilities furnished by employer—attach statement

showing how it was determined):

a Home (lodging) 21a

b Meals 21b

c Car 21c

d Other property or facilities. List type and amount.  

21d

22 Allowances, reimbursements, or expenses paid on your behalf for services you performed:

a Cost of living and overseas differential 22a

b Family 22b

c Education 22c

d Home leave 22d

e Quarters 22e

f For any other purpose. List type and amount. 

22f

g Add lines 22a through 22f 22g

23 Other foreign earned income. List type and amount. 

23

24 Add lines 19 through 21d, line 22g, and line 23 24

25 Total amount of meals and lodging included on line 24 that is excludable (see instructions) 25

Subtract line 25 from line 24. Enter the result here and on line 27 on page 3. This is your 2002

foreign earned income 

26

26

Part III

Part IV

Form 2555 (2002)
2-12 Lesson 2

Draft as of

5/14/2002

Form 2555 (2002) Page 3

Taxpayers Claiming the Housing Exclusion and/or Deduction

28 Qualified housing expenses for the tax year (see instructions) 28

Number of days in your qualifying period that fall within your 2002 tax

year (see instructions)

29

29

30 Multiply $29.70 by the number of days on line 29. If 365 is entered on line 29, enter $10,842.00 here 30

31

Subtract line 30 from line 28. If the result is zero or less, do not complete the rest of this part

or any of Part IX

31

32 Enter employer-provided amounts (see instructions) 32

Divide line 32 by line 27. Enter the result as a decimal (rounded to at least three places), but do

not enter more than “1.000”

33

33

Housing exclusion. Multiply line 31 by line 33. Enter the result but do not enter more than the

amount on line 32. Also, complete Part VIII 

34

34

Note: The housing deduction is figured in Part IX. If you choose to claim the foreign earned

income exclusion, complete Parts VII and VIII before Part IX.

Taxpayers Claiming the Foreign Earned Income Exclusion

35 Maximum foreign earned income exclusion 35 $80,000 00

● All others, enter the number of days in your qualifying period that

fall within your 2002 tax year (see the instructions for line 29).

36

● Otherwise, divide line 36 by the number of days in your 2002 tax year and enter the result

as a decimal (rounded to at least three places).

37

38 Multiply line 35 by line 37 38

39 Subtract line 34 from line 27 39

40 Foreign earned income exclusion. Enter the smaller of line 38 or line 39. Also, complete Part VIII  40

Taxpayers Claiming the Housing Exclusion, Foreign Earned Income Exclusion, or Both

41 Add lines 34 and 40 41

Deductions allowed in figuring your adjusted gross income (Form 1040, line 35) that are allocable

to the excluded income. See instructions and attach computation

42

42

Subtract line 42 from line 41. Enter the result here and in parentheses on Form 1040, line 21.

Next to the amount enter “Form 2555.” On Form 1040, subtract this amount from your income

to arrive at total income on Form 1040, line 22 

43

43

Taxpayers Claiming the Housing Deduction—Complete this part only if (a) line 31 is more than line

34 and (b) line 27 is more than line 41.

44 Subtract line 34 from line 31 44

45 Subtract line 41 from line 27 45

46 Enter the smaller of line 44 or line 45 46

Note: If line 45 is more than line 46 and you could not deduct all of your 2001 housing deduction

because of the 2001 limit, use the worksheet on page 4 of the instructions to figure the

amount to enter on line 47. Otherwise, go to line 48.

47 Housing deduction carryover from 2001 (from worksheet on page 4 of the instructions) 47

48 Housing deduction. Add lines 46 and 47. Enter the total here and on Form 1040 to the left of

line 34. Next to the amount on Form 1040, enter “Form 2555.” Add it to the total adjustments

reported on that line  48

 .

 .

Part VIII

Part VII

Part VI

Part IX

Part V

36 ● If you completed Part VI, enter the number from line 29.

37 ● If line 36 and the number of days in your 2002 tax year (usually 365) are the same, enter “1.000.”

27

All Taxpayers

27 Enter the amount from line 26

Are you claiming the housing exclusion or housing deduction?

No. Go to Part VII.





Yes. Complete Part VI.

Form 2555 (2002)

days

days
DEDUCTIONS ALLOCABLE TO EXCLUDED INCOME

In section VIII of Form 2555, the taxpayer is required to list

the deductions allowed in figuring adjusted gross income that

are allocable to the excluded income. To the extent a deduction

that is allocable to the excluded income is claimed, the exclusion must be reduced by the deduction.

The three most common deductions that may affect the exclusion are self-employment tax, itemized deductions and

moving expenses.

If the taxpayer has any deductions attributable to the excluded

foreign earned income, follow the instructions in Form 2555 for

how to allocate the expenses.

 SUMMING UP THIS LESSON 

The foreign earned income exclusion does not apply to income

from the U.S. government, regardless of the tax home. The

exclusion can be up to $80,000 for income earned in a foreign

country. It is necessary to complete either Form 2555 or

2555EZ to claim the exclusion.

In this lesson, we have discussed the basic examples of the

exclusion. When a taxpayer has a more complex situation, he

or she will need to seek professional tax assistance.

Lesson 2 2-13
2-14 Lesson 2

1. No, Puerto Rico is not considered a foreign country. 

2. His 2002 tax home is China.

3. No.

4. No, she was not present in the foreign country for a full 

330 days.

5. No, U.S. military pay is not eligible.

6. No, only earned income is eligible.

7. Yes, Kim’s salary.

8. a. Form 2555EZ

b. Form 2555

c. Form 2555

FOREIGN EARNED

INCOME EXCLUSION ANSWERS TO EXERCISES

LESSON 2
1. List the two forms that the foreign earned income exclusion

can be claimed on.

2. Is a taxpayer required to take the exclusion on foreign

earned income?

3. Are military wages eligible for the foreign earned income

exclusion?

4. Complete the form 2555EZ on the next two pages using the

following information.

Robert (000-00-0001) and Sara (000-00-0002) Johnson (both

U.S. citizens) have lived in Germany since August, 2001.

Robert is employed by the U.S. Armed Forces. In 2002, Sara

worked at a local bakery (Gulden’s, 349028 Gulden Lane,

Munich, Germany) in Germany and earned the equivalent of

$12,000. Robert and Sara do not consider themselves bona fide

residents of Germany. During 2002, they resided in Germany

for the full year, except for a three day vacation period in

France. Their address in Germany is 239084 Marzolf Lane,

Munich, Germany. They have never claimed the foreign earned

income exclusion before.

Lesson 2 2-15

SUMMARY EXERCISES LESSON 2
2-16 Lesson 2

Draft as of

5/15/2002

General Information

OMB No. 1545-1326

Foreign Earned Income Exclusion Form 2555-EZ

Department of the Treasury

Internal Revenue Service  See separate instructions.  Attach to Form 1040.

Name shown on Form 1040 Your social security number

Your foreign address (including country) Your occupation

Employer’s name

For Paperwork Reduction Act Notice, see page 3 of separate instructions. Cat. No. 13272W Form 2555-EZ (2002)

4 5

6

9 Employer is (check any that apply):

A U.S. business

A foreign business

Other (specify) 

10a

If you answered “Yes,” enter the tax year for which the revocation was effective. 

b Of what country are you a citizen/national? 

Have you ever revoked the foreign earned income exclusion? Yes No

7 Employer’s U.S. address (including ZIP code) 8 Employer’s foreign address

● Are a U.S. citizen or a resident alien.

● Earned wages/salaries in a foreign country.

● Had total foreign earned income of

$80,000 or less.

● Do not have self-employment income.

● Do not have business/moving expenses. And You:

You May Use

This Form

If You:

b

c

a

b

c

● Do not claim the foreign housing

exclusion or deduction.

Part II

● Are filing a calendar year return that

covers a 12-month period.

11a List your tax home(s) during 2002 and date(s) established. 

If you filed Form 2555 or 2555-EZ after 1981, enter the last year you filed the form. 

If you did not file Form 2555 or 2555-EZ after 1981, check here  and go to line 11a now.

d

1 Bona Fide Residence Test

Yes No

Enter the date your bona fide residence began  , and ended (see instructions)  .

2 Physical Presence Test

Yes No

b

a

b

a

Tests To See If You Can Take the Foreign Earned Income Exclusion

Were you a bona fide resident of a foreign country or countries for a period that includes an entire tax year

(see page 2 of the instructions)?

Were you physically present in a foreign country or countries for at least 330 full days during—

● If you answered “Yes,” you meet this test. Fill in line 1b and then go to line 3.

● If you answered “No,” you do not meet this test. Go to line 2 to see if you meet the Physical Presence Test.

2002 or

any other period of 12 months in a row starting or ending in 2002?

● If you answered “Yes,” you meet this test. Fill in line 2b and then go to line 3.

● If you answered “No,” you do not meet this test. You cannot take the exclusion unless you meet the

Bona Fide Residence Test above.

The physical presence test is based on the 12-month period from  

● If you answered “No,” you cannot take the exclusion. Do not file this form.

Tax Home Test. Was your tax home in a foreign country or countries throughout your period of bona fide

residence or physical presence, whichever applies?

 

through  .

3

Yes No

● If you answered “Yes,” you can take the exclusion. Complete Part II below and then go to page 2.

Part I

Attachment

(99) Sequence No. 34A

2002
Lesson 2 2-17

Draft as of

5/15/2002

Form 2555-EZ (2002) Page 2

$80,000 00

Enter the number of days in your qualifying period that fall within 2002

Did you enter 365 on line 14?

Multiply line 13 by line 15

 .

Enter, in U.S. dollars, the total foreign earned income you earned and received in 2002 (see

instructions). Be sure to include this amount on Form 1040, line 7

Foreign earned income exclusion. Enter the smaller of line 16 or line 17 here and in

parentheses on Form 1040, line 21. Next to the amount enter “2555-EZ.” On Form 1040, subtract

this amount from your income to arrive at total income on Form 1040, line 22 

18

13

14

15

16

17

Maximum foreign earned income exclusion 13

14

15

17

18

16

Part IV Figure Your Foreign Earned Income Exclusion

Enter “1.000.”

Part III

(d) Income earned in U.S. 

on business (attach computation)

(c) Number of days

in U.S. on business (a) Date arrived in U.S. (b) Date left U.S.

Days Present in the United States—Complete this part if you were in the

United States or its possessions during 2002.

12

Divide line 14 by 365 and enter the result as

a decimal (rounded to at least three places).

Yes.

No.

days

Form 2555-EZ (2002)
2-18 Lesson 2

1. Form 2555 and Form 2555EZ.

2. No, it is voluntary.

3. No.

4. See the completed form on the next two pages.

FOREIGN EARNED

INCOME EXCLUSION ANSWERS TO SUMMARY EXERCISES

LESSON 2
Lesson 2 2-19

Draft as of

5/15/2002

General Information

OMB No. 1545-1326

Foreign Earned Income Exclusion Form 2555-EZ

Department of the Treasury

Internal Revenue Service  See separate instructions.  Attach to Form 1040.

Name shown on Form 1040 Your social security number

Your foreign address (including country) Your occupation

Employer’s name

For Paperwork Reduction Act Notice, see page 3 of separate instructions. Cat. No. 13272W Form 2555-EZ (2002)

4 5

6

9 Employer is (check any that apply):

A U.S. business

A foreign business

Other (specify) 

10a

If you answered “Yes,” enter the tax year for which the revocation was effective. 

b Of what country are you a citizen/national? 

Have you ever revoked the foreign earned income exclusion? Yes No

7 Employer’s U.S. address (including ZIP code) 8 Employer’s foreign address

● Are a U.S. citizen or a resident alien.

● Earned wages/salaries in a foreign country.

● Had total foreign earned income of

$80,000 or less.

● Do not have self-employment income.

● Do not have business/moving expenses. And You:

You May Use

This Form

If You:

b

c

a

b

c

● Do not claim the foreign housing

exclusion or deduction.

Part II

● Are filing a calendar year return that

covers a 12-month period.

11a List your tax home(s) during 2002 and date(s) established. 

If you filed Form 2555 or 2555-EZ after 1981, enter the last year you filed the form. 

If you did not file Form 2555 or 2555-EZ after 1981, check here  and go to line 11a now.

d

1 Bona Fide Residence Test

Yes No

Enter the date your bona fide residence began  , and ended (see instructions)  .

2 Physical Presence Test

Yes No

b

a

b

a

Tests To See If You Can Take the Foreign Earned Income Exclusion

Were you a bona fide resident of a foreign country or countries for a period that includes an entire tax year

(see page 2 of the instructions)?

Were you physically present in a foreign country or countries for at least 330 full days during—

● If you answered “Yes,” you meet this test. Fill in line 1b and then go to line 3.

● If you answered “No,” you do not meet this test. Go to line 2 to see if you meet the Physical Presence Test.

2002 or

any other period of 12 months in a row starting or ending in 2002?

● If you answered “Yes,” you meet this test. Fill in line 2b and then go to line 3.

● If you answered “No,” you do not meet this test. You cannot take the exclusion unless you meet the

Bona Fide Residence Test above.

The physical presence test is based on the 12-month period from  

● If you answered “No,” you cannot take the exclusion. Do not file this form.

Tax Home Test. Was your tax home in a foreign country or countries throughout your period of bona fide

residence or physical presence, whichever applies?

 

through  .

3

Yes No

● If you answered “Yes,” you can take the exclusion. Complete Part II below and then go to page 2.

Part I

Attachment

(99) Sequence No. 34A

2002

Sara Johnson 000 00 0002

X

X

X

Jan. Dec.

239084 Marzolf Lane

Munich, Germany baker

Gulden’s

349028 Gulden Lane

Munich, Germany

X

X

Germany

U.S.
2-20 Lesson 2

Draft as of

5/15/2002

Form 2555-EZ (2002) Page 2

$80,000 00

Enter the number of days in your qualifying period that fall within 2002

Did you enter 365 on line 14?

Multiply line 13 by line 15

 .

Enter, in U.S. dollars, the total foreign earned income you earned and received in 2002 (see

instructions). Be sure to include this amount on Form 1040, line 7

Foreign earned income exclusion. Enter the smaller of line 16 or line 17 here and in

parentheses on Form 1040, line 21. Next to the amount enter “2555-EZ.” On Form 1040, subtract

this amount from your income to arrive at total income on Form 1040, line 22 

18

13

14

15

16

17

Maximum foreign earned income exclusion 13

14

15

17

18

16

Part IV Figure Your Foreign Earned Income Exclusion

Enter “1.000.”

Part III

(d) Income earned in U.S. 

on business (attach computation)

(c) Number of days

in U.S. on business (a) Date arrived in U.S. (b) Date left U.S.

Days Present in the United States—Complete this part if you were in the

United States or its possessions during 2002.

12

Divide line 14 by 365 and enter the result as

a decimal (rounded to at least three places).

Yes.

No.

days

Form 2555-EZ (2002)

365

$80,000

$12,000

$12,000

1 000

X
Lesson 3 3-1

OBJECTIVES

At the end of this lesson, you will be able to:

1. Determine who qualifies for an extension of deadline to file

returns and take care of tax matters.

2. Identify special tax benefits that are available to persons who

die in a combat zone or from a terrorist or military action.

3. Explain how to file claims for tax forgiveness for these 

individuals.

INTRODUCTION

This lesson describes some of the tax benefits that are available

to those serving in a combat zone. Some of these tax benefits

are also covered in Lesson 1, Gross Income; Lesson 11, Sale of

Home; and Lesson 15, Filing Returns.

Service in the Persian Gulf area, the former Yugoslavia,

Afghanistan and its airspace, and Yemen are eligible for combat

zone tax treatment. In addition, U.S. military personnel

located in the Federal Republic of Yugoslavia, Albania, the

Adriatic Sea, and the northern Ionian Sea, including all of their

air space in connection with the Kosovo operation, are eligible

for combat zone tax treatment. Members of the Armed Forces

deployed overseas away from their permanent duty station in

support of operations in a qualified hazardous duty area, but

outside the qualified hazardous duty area, are treated as if

they are in a combat zone solely for the purposes of the extension deadlines. These personnel are not entitled to other combat zone tax benefits. Military members serving in these

designated areas are automatically granted additional time to

take action on any tax matter. The IRS will not impose penalties or interest on members during an extension period.

EXTENSION OF DEADLINE

Members of the Armed Forces who served in a combat zone are

allowed additional time to take care of tax matters. This extension also applies to any individual who is deployed from his or

her permanent duty station in support of operations in a qualified hazardous duty area, or performing qualifying service outside the qualified hazardous duty area. The law provides that

TAX BENEFITS FOR COMBAT

ZONE PARTICIPANTS

LESSON 3
3-2 Lesson 3

certain periods of time are disregarded when determining

whether certain tax matters have been taken care of on time.

For ease of understanding, this publication refers to these provisions as “extensions of deadlines.” These deadline extensions

should not be confused with other parts of the tax law that

refer to extensions of time for performing acts.

The deadline for filing tax returns, paying taxes, filing claims

for refund, and taking other actions with the IRS is automatically extended if the taxpayer serves in the Armed Forces in a

combat zone. The deadline for IRS to take certain actions, such

as collection and examination actions, is also extended.

Additionally, if members of the Armed Forces are deployed

overseas away from their permanent duty station in support of

operations in a qualified hazardous duty area, but outside the

qualified hazardous duty area, they also receive these extensions (but not other combat zone benefits). The deadline for IRS

to take certain actions, such as collection and examination

actions, is also extended. See Lesson 1 for the beginning dates

for the Afghanistan area combat zone, the Kosovo area combat

zone, the Persian Gulf area combat zone, and the qualified hazardous duty areas. 

The deadline for taking actions with the IRS is extended for

180 days after the later of:

1. The last day the taxpayer is in a combat zone/qualified hazardous duty area or have qualifying service outside of the

combat zone/qualified hazardous duty area (or the last day

the area qualifies as a combat zone or qualified hazardous

duty area), or

2. The last day of any continuous qualified hospitalization

(defined later) for injury from service in the combat

zone/qualified hazardous duty area or while performing

qualifying service outside of the combat zone/qualified hazardous duty area.

In addition to the 180 days, the deadline is also extended by

the number of days remaining for the member to take the

action with the IRS when he/she entered a combat zone/qualified hazardous duty area (or began performing qualifying service outside the combat zone/qualified hazardous duty area). If

a taxpayer entered the combat zone/qualified hazardous duty

area (or began performing qualifying service outside the combat zone/qualified hazardous duty area) before the period of

time to take the action began, the deadline is extended by the

entire period of time he/she has to take the action.
Example

Captain Margaret Jones entered Saudi Arabia on December 1,

2000. She remained there through March 31, 2002, when she

departed for the United States. She was not injured and did

not return to the combat zone. The deadlines for filing Captain

Jones’ 2000, 2001, and 2002 returns are figured as follows.

• The 2000 tax return. The deadline is January 10, 2003.

This deadline is 285 days (180 plus 105) after Captain

Jones’ last day in the combat zone (March 31, 2002). The

105 additional days are the number of days in the 3 1/2

month filing period that were left when she entered the

combat zone (January 1 - April 15, 2001).

• The 2001 tax return. The deadline is January 10, 2003.

The deadline is 285 days (180 plus 105) after Capt. Jones’

last day in the combat zone (March 31, 2002).

• The 2002 tax return. The deadline is not extended because

the 180-day extension period after March 31, 2002, ends on

September 27, 2002, which is before the start of the filing

period for her 2002 return (January 1 - April 15, 2003).

Example

Petty Officer Leonard Brown’s ship entered the Persian Gulf on

January 5, 2001. On February 15, 2001, Leonard was injured

and was flown to a U.S. hospital. He remained in the hospital

through April 20, 2002. The deadlines for filing Petty Officer

Brown’s 2000, 2001, and 2002 returns are figured as follows.

• The 2000 tax return. The deadline is January 27, 2003.

Petty Officer Brown has 280 days (180 plus 100) after his

last day in the hospital (April 21, 2002) to file his 2000

return. The 100 additional days are the number of days in

the 3 1/2 month filing period that were left when he entered

the combat zone (January 5 - April 15).

• The 2001 tax return. The deadline is January 27, 2003.

Petty Officer Brown has 280 days (180 plus 100) after April

21, 2002, to file his 2001 tax return. The 100 additional

days are the number of days in the 2002 filing period that

were left when he entered the combat zone.

• The 2002 tax return. The deadline is not extended

because the 180-day extension period after April 21, 2002,

ends on October 18, 2002, which is before the start of the filing period for his 2002 return (January 1 - April 15, 2003).

Example

You generally have 3 years from April 15, 1998, to file a claim

for refund against your timely filed 1997 tax return. This

means that your claim normally must be filed by April 15,

2001. However, if you served in a combat zone from November

1, 2000, through March 23, 2001, and were not injured, your

Lesson 3 3-3
3-4 Lesson 3

deadline for filing that claim is extended 346 days (180 plus

166) after you leave the combat zone. This extends your deadline to March 4, 2002. The 166 additional days are the number

of days in the 3-year period for filing the refund claim that

were left when you entered the combat zone on November 1

(November 1, 2000 - April 15, 2001).

Missing status. Time in a missing status (missing in action or

prisoner of war) counts as time in a combat zone or a qualified

hazardous duty area.

Support personnel. The deadline extension provision also

applies if a taxpayer is serving in a combat zone or a qualified

hazardous duty area in support of the Armed Forces. This

includes Red Cross personnel, accredited correspondents, and

civilian personnel acting under the direction of the Armed

Forces in support of those forces.

Qualified hospitalization. The hospitalization must be the

result of an injury received while serving in a combat zone or a

qualified hazardous duty area. Qualified hospitalization means:

1. Any hospitalization outside the United States, and

2. Up to 5 years of hospitalization in the United States.

Actions Extended

The actions to which the deadline extension provision applies

include:

• Filing any return of income, estate, or gift tax (except

employment and withholding taxes),

• Paying any income, estate, or gift tax (except employment

and withholding taxes),

• Filing a petition with the Tax Court for redetermination of a

deficiency or for review of a Tax Court decision,

• Filing a claim for credit or refund of any tax,

• Bringing suit for any claim for credit or refund,

• Making a qualified retirement contribution to an IRA,

• Allowing a credit or refund of any tax by IRS,

• Assessment of any tax by the IRS,

• Giving or making any notice or demand by the IRS for the

payment of any tax or for any liability for any tax,

• Collection by the IRS of any tax due, and

• Bringing suit by the United States for any tax due.

If the IRS takes any actions covered by these provisions or

sends the taxpayer a notice of examination before learning that

LESSON 1
they are entitled to an extension of the deadline, the taxpayer

should contact their legal assistance office. No penalties or

interest will be imposed for failure to file a return or pay taxes

during the extension period.

Spouses. Spouses of individuals who served in a combat zone

are entitled to the same deadline extension with two exceptions.

1. The extension does not apply to a spouse for any tax year

beginning more than 2 years after the date the area ceases

to be a combat zone.

2. The extension does not apply to a spouse for any period the

qualifying individual is hospitalized in the United States for

injuries incurred in a combat zone.

Not in a combat zone. Reservists called to active duty or regular military member who are not in a combat zone may still

qualify to defer the payment of back taxes. To qualify, these

individuals must:

• Be serving their initial period of service and

• Show that their ability to pay the back taxes has been 

materially impaired.

Initial period of service. 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.

Material impairment. To indicate material impairment, the

taxpayer must show that his or her income dropped as a result

of going into military service.

Request for deferment. Military members who have a current payment agreement or who have received a notice requesting payment must make a written request for deferment to the

IRS office where you have the agreement. 

Information needed. The request for deferment must include

the member’s name, social security number, monthly income

and source of income before military service, current monthly

income, military rank, date of entry into the military service,

and date the member is eligible for discharge. Enclosing a copy

of the military orders is helpful.

The IRS will review each request and advise the taxpayer in

writing of its decision. Should the taxpayer need further assistance, they can call the IRS at 1-800-829-1040 to discuss their

Lesson 3 3-5
3-6 Lesson 3

situation. If the IRS grants the request for deferment, the taxpayer will be able to defer payment of back taxes until 6

months after the end of his/her initial period of service.

DECEDENTS

Special tax forgiveness provisions apply to individuals who:

• Die while serving in a combat zone or from wounds, disease,

or injury incurred while serving in a combat zone, or

• Die from wounds or injury incurred in a terrorist or military

action while a U.S. employee.

Filing a Decedent Return

The personal representative (executor, administrator, or anyone

who is in charge of the decedent’s property) must file the final

income tax return (Form 1040) of the decedent for the year of

death and any returns not filed for preceding years. A surviving

spouse, under certain circumstances, may have to file the

returns for the decedent. See Joint Return, later.

Return for preceding year. If an individual died after the

close of the tax year, but before the return for that year was

filed, the return for the year just closed will not be the final

return. The return for that year will be a regular return and

the personal representative must file it.

Example

Samantha Smith died on March 21, 2001, before filing her 2000

tax return. Her personal representative must file her 2000

return by April 16, 2001. Her final tax return is due April 15,

2002.

When and Where To File

The final income tax return is due at the same time the decedent’s return would have been due had death not occurred. A

final return for a decedent who was a calendar year taxpayer is

generally due on April 15 following the year of death, regardless of when during that year death occurred. 

The tax return must be prepared on a form for the year of

death regardless of when during the year death occurred. 

Generally, you must file the final income tax return of the decedent with the Internal Revenue Service center for the place

where you live. A tax return for a decedent cannot be electronically filed. A paper tax return must be filed for the decedent.
Combat Zone Forgiveness

Federal income tax liability is forgiven for U.S. military personnel who die while serving in a combat zone or as a result of

wounds, disease, or injury incurred while so serving. The forgiveness of tax applies for the year of death and for any prior

year ending on or after the first day that the individual served

in a combat zone in active service. Any forgiven tax liability

that has already been paid will be refunded, and any unpaid

tax liability at the date of death will be forgiven.

This forgiveness provision also applies to a member of the

Armed Forces serving outside the combat zone if the service:

1. Was in direct support of military operations in the zone, and

2. Qualified the member for special military pay for duty 

subject to hostile fire or imminent danger. 

Missing status. The date of death for a member of the Armed

Forces who was in a missing status (missing in action or prisoner of war) is the date his or her name is removed from missing

status for military pay purposes. This is true even if death

actually occurred earlier.

Tax Forgiveness for Deaths Due to Military or Terroristic Actions

A decedent’s income tax liability may be forgiven if his or her

death was due to service in a combat zone or to military or terroristic actions.

The Victims of Terrorism Tax Relief Act of 2001 provides tax

relief for those injured or killed as a result of terrorist attacks,

certain survivors of those killed as a result of terrorist attacks,

and others who were affected by terrorist attacks. For information on that Act, see Publication 3920.

Military or Terroristic Actions

The decedent’s income tax liability is forgiven if, at death, he or

she was a military or civilian employee of the United States

who died because of wounds or injury incurred:

• While a U.S. employee, and 

• In a military or terroristic action.

For tax years ending after September 10, 2001, tax liability is

forgiven for an individual who dies from wounds or injury

incurred while a U.S. employee in a terroristic or military

action regardless of where the action occurred.

The forgiveness applies to the tax year in which death occurred

and for any prior tax year in the period beginning with the year

before the year in which the wounds or injury occurred.

Lesson 3 3-7

LESSON 1
3-8 Lesson 3

Military or terroristic action defined. A military or terroristic action means the following.

• Any terroristic activity that most of the evidence indicates

was directed against the United States or any of its allies. 

• Any military action involving the U.S. Armed Forces and

resulting from violence or aggression against the United

States or any of its allies, or the threat of such violence or

aggression.

Military action does not include training exercises. Any multinational force in which the United States is participating is

treated as an ally of the United States.

Claims for Credit or Refund

If any of these tax-forgiveness situations applies to a prior year

tax, any tax paid for which the period for filing a claim has not

ended will be credited or refunded. If any tax is still due, it will

be canceled. The normal period for filing a claim for credit or

refund is 3 years after the return was filed or 2 years after the

tax was paid, whichever is later.

If death occurred in a combat zone or from wounds, disease, or

injury incurred in a combat zone, the period for filing the claim

is extended by:

• The amount of time served in the combat zone (including any

period in which the individual was in missing status), plus 

• The period of continuous qualified hospitalization for injury

from service in the combat zone, if any, plus 

• The next 180 days. 

• Qualified hospitalization means any hospitalization outside

the United States and any hospitalization in the United

States of not more than 5 years.

Filing a claim. Use the following procedures to file a claim. 

• File Form 1040, 1040A, or 1040EZ if an income tax return

has not been filed for the tax year. Form W-2, Wage and Tax

Statement, must accompany all returns. 

• File Form 1040X if an income tax return has been filed. A

separate Form 1040X must be filed for each year in question.
These returns and claims must be filed with the Internal

Revenue Service, P.O. Box 4053, Woburn, MA 01888. 

All returns and claims must be identified by writing “Enduring

Freedom—KIA,” “Kosovo Operation — KIA,” “Desert Storm —

KIA,” or “Former Yugoslavia — KIA” in bold letters on the top

of page 1 of the return or claim. On Forms 1040 and 1040X, the

phrase “Enduring Freedom—KIA,” “Kosovo Operation — KIA,”

“Desert Storm — KIA,” or “Former Yugoslavia — KIA” must be

written on the line for total tax. If the individual was killed in

a terroristic or military action outside the United States, put

“KITA” on the front of the return and on the line for total tax. 

An attachment should accompany any return or claim that

includes a computation of the decedent’s tax liability before any

amount is forgiven and the amount that is to be forgiven. For

joint returns, see Joint returns, later.

Necessary documents. The following documents must

accompany all returns and claims for refund. For returns and

claims relating to individuals who died as a result of a terrorist

attack, see Publication 3920.

• Form 1310, Statement of Person Claiming Refund Due a

Deceased Taxpayer. 

• A certification from the Department of Defense or the

Department of State that the death was due to a military or

terroristic action.

For military employees and civilian employees of the

Department of Defense, certification must be made by that

department on Form DOD 1300, Report of Casualty. For other

civilian employees who die as a result of wounds or injury

incurred outside the United States, certification must be a letter signed by the Director General of the Foreign Service,

Department of State, or his/her delegate. The certification must

include the individual’s name and social security number, the

date of injury, the date of death, and a statement that the individual died as the result of a military or terroristic action outside the United States and was an employee of the United

States at the date of injury and at the date of death.

If the certification has been received, but you do not have

enough tax information to file a timely claim for refund, file

Form 1040X. Attach Form 1310 and a statement that an

amended claim will be filed as soon as the required tax information is available.

Joint returns. Only the decedent’s part of the joint income

tax liability is eligible for the refund or tax forgiveness. To

determine the part for the decedent, the person filing the claim

must complete the following steps:

Lesson 3 3-9
3-10 Lesson 3

1. Figure the income tax for which the decedent would have

been liable if a separate return had been filed.

2. Figure the income tax for which the spouse would have been

liable as if a separate return had been filed.

3. Multiply the joint tax liability by a fraction. The top number

of the fraction is the amount in (1) above. The bottom number

of the fraction is the total of (1) and (2).

The amount in (3) is the decedent’s tax liability that is eligible

for the refund or tax forgiveness. If a taxpayer is unable to

complete this process, he or she should attach a statement of

all income and deductions indicating the part that belongs to

each spouse. The IRS will make the proper allocation.

Residents of community property states. If the member of

the Armed Forces was domiciled in a community property state

and the spouse reported half the military pay on a separate

return, the spouse can get a refund of taxes paid on his or her

share of the pay for the years involved. The forgiveness of

unpaid tax on the military pay would also apply to the half

owed by the spouse for the years involved. 

Exercise 1

Major Joe Wells entered Afghanistan on 6 January 2002. He

remained there through 7 April 2002, when he departed for the

United States. He was not injured and did not return to the

combat zone.

What is the deadline for filing Major Wells’ 2001 tax return?

Answer __________________________________________
Exercise 2

Mr. Tim Morris, a civilian employee of the United States, died

in 2003 as a result of injuries he suffered during a terrorist

attack in 2001.

What years are Mr. Morris’ income liabilities forgiven? 

Answer __________________________________________

Lesson 3 3-11

JANUARY 2002

S MTW T F S

1 2 3 4 5

6 7 8 9 10 11 12

13 14 15 16 17 18 19

20 21 22 23 24 25 26

27 28 29 30 31

APRIL 2002

S MTW T F S

1 2 3 4 5 6

7 8 9 10 11 12 13

14 15 16 17 18 19 20

21 22 23 24 25 26 27

28 29 30

JULY 2002

S MTW T F S

1 2 3 4 5 6

7 8 9 10 11 12 13

14 15 16 17 18 19 20

21 22 23 24 25 26 27

28 29 30 31

OCTOBER 2002

S MTW T F S

1 2 3 4 5

6 7 8 9 10 11 12

13 14 15 16 17 18 19

20 21 22 23 24 25 26

27 28 29 30 31

FEBRUARY 2002

S MTW T F S

1 2

3 4 5 6 7 8 9

10 11 12 13 14 15 16

17 18 19 20 21 22 23

24 25 26 27 28

MAY 2002

S MTW T F S

1 2 3 4

5 6 7 8 9 10 11

12 13 14 15 16 17 18

19 20 21 22 23 24 25

26 27 28 29 30 31

AUGUST 2002

S MTW T F S

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 27 28 29 30 31

NOVEMBER 2002

S MTW T F S

1 2

3 4 5 6 7 8 9

10 11 12 13 14 15 16

17 18 19 20 21 22 23

24 25 26 27 28 29 30

MARCH 2002

S MTW T F S

1 2

3 4 5 6 7 8 9

10 11 12 13 14 15 16

17 18 19 20 21 22 23

24 25 26 27 28 29 30

31

JUNE 2002

S MTW T F S

1

2 3 4 5 6 7 8

9 10 11 12 13 14 15

16 17 18 19 20 21 22

23 24 25 26 27 28 29

30

SEPTEMBER 2002

S MTW T F S

1 2 3 4 5 6 7

8 9 10 11 12 13 14

15 16 17 18 19 20 21

22 23 24 25 26 27 28

29 30

DECEMBER 2002

S MTW T F S

1 2 3 4 5 6 7

8 9 10 11 12 13 14

15 16 17 18 19 20 21

22 23 24 25 26 27 28

29 30 31

2002

JANUARY 2003

SM TW T F S

1234

5 6 7 8 9 10 11

12 13 14 15 16 17 18

19 20 21 22 23 24 25

26 27 28 29 30 31
3-12 Lesson 3

 SUMMING UP THIS LESSON 

In this lesson you have learned that:

 The deadline for filing tax returns, paying taxes, and taking

other actions with the Internal Revenue Service is automatically extended if an individual serves in a combat zone.

 The income tax liability of a member of the Armed Forces is

forgiven if a member dies as a result of service in a combat

zone or from a terrorist or military action outside the

United States.

 The terrorist or military action forgiveness also applies to

an individual who is a U.S. employee at death and who dies

from wounds or injury incurred while a U.S. employee in a

terrorist or military action regardless of where the action

occured.
Exercise 1– The 2001 tax return. The deadline is 12 January

2003. The deadline is 280 days (180 plus 100) after

Major West’s last day in the combat zone (7 April

2002). The 100 additional days are the number of

days in the 3 1/2 month filing period that were left

when he entered the combat zone (6 January - 15

April 2002).

Exercise 2– 2000-2003

Lesson 3 3-13

TAX BENEFITS FOR COMBAT

ZONE PARTICIPANTS ANSWERS TO EXERCISES

LESSON 3
3-14 Lesson 3

STUDENT NOTES
OBJECTIVES

At the end of this lesson, you will be able to:

1. Determine whether an alien should file a resident, nonresident, or dual-status tax return.

2. Determine what sources of income an alien must report on

his or her return.

3. Explain the special choice that permits a nonresident alien

spouse of a U.S. citizen or resident to be treated as a resident

alien and file a joint return.

INTRODUCTION

Although the Volunteer Assistor’s Guide discusses the filing

status of a taxpayer, you will need more information to answer

questions about aliens that members of the Armed Forces may

ask. An alien may be classified in one of three categories: 

resident, nonresident, or dual-status. It is not always easy to

determine the correct category. An alien’s status, however, is

crucial in determining what type of income he or she must

report and what tax form to file. This is discussed in detail in

Publication 519, U.S. Tax Guide for Aliens.

NONRESIDENT ALIENS

A nonresident alien is an individual who is not a citizen or resident of the United States. A nonresident alien generally must

pay tax only on income received from sources within the United

States. If the income is connected with conducting a trade or

business in the United States, the income (after allowable

deductions) is taxed at regular U.S. tax rates. If other income

from U.S. sources is not connected with conducting a trade or

business in the United States, it is taxed at a flat 30% (or lower

treaty) rate. For example, Survivor Benefit Plan payments

made to a nonresident alien surviving spouse may be subject to

a 30% withholding (or lower treaty) rate. In either case, the

nonresident alien must file a Form 1040NR, U.S. Nonresident

Alien Income Tax Return.

Lesson 4 4-1

ALIENS

LESSON 4
4-2 Lesson 4

RESIDENT ALIENS

An alien may qualify as a U.S. resident for tax purposes by

meeting either the green card test or the substantial presence

test for the calendar year. 

Green card test. An alien is a resident for tax purposes if he

or she is a lawful permanent resident of the United States

(holder of a green card) at any time during the calendar year.

However, see the discussion on Dual-Status Aliens, later. 

Substantial presence test. If the alien does not meet the

green card test, the alien may still be a U.S. resident for tax

purposes if the substantial presence test for the calendar year

is met. To meet this test, the alien must have been physically

present in the United States for at least 31 days during 2002

and for a total of at least 183 days in 2002, 2001, and 2000.

When you count the days for the substantial presence test,

count:

1. All the days the alien was present in 2002,

2. One-third of the days present in 2001, and

3. One-sixth of the days present in 2000. 

Example

Ana Garcia was present in the United States for several years.

She believes that she can qualify for the substantial presence

test. Ana was here from December 1 through December 31 of

2002. She was present in the U.S. all of 2001. In 2000, she

stayed in the United States from June 1 through December 31.

Here’s how to figure if Ana meets the substantial presence test:

YEAR MULTIPLY BY DAYS PRESENT TOTAL

2002 1 31 = 31

2001 1/3 365 = 122

2000 1/6 214 = 36

189

Since Ana was present in the United States at least 31 days in

2002 and at least 183 days during the current and last two years,

she meets the test in 2002 to qualify as a resident of the U.S.

Exceptions. For purposes of counting days for the substantial

presence test, there are exceptions for regular commuters from

Canada or Mexico, persons in transit through the United States,

persons who are unable to leave because of becoming ill while

in the United States, diplomats, employees of international

organizations, teachers, trainees, and students. Also, the substantial presence test does not apply if the alien was present in
the United States for fewer than 183 days during 2002 and

establishes that he or she has a closer connection to a foreign

country. Publication 519 has more details on these exceptions.

First-year choice. If the alien does not meet the green card test

or the substantial presence test for 2001 or 2002, and did not

choose to be treated as a resident for part of 2001, but will meet

the substantial presence test for 2003, he or she can choose to

be treated as a U.S. resident for part of 2002. To make this

choice, he or she must have been:

1. Present in the U.S. for at least 31 consecutive days in 2002,

and

2. Present in the U.S. for at least 75% of the days beginning

with the first day of the 31-day period in (1) and ending with

the last day of 2002.

The taxpayer should be referred to Publication 519 for complete

details concerning this special first-year choice. This choice,

once made, cannot be revoked without the consent of the

Internal Revenue Service.

Resident aliens generally are taxed on their worldwide income,

the same as U.S. citizens. Resident aliens use the same tax

forms as U.S. citizens.

DUAL-STATUS ALIENS

An alien may be both a nonresident and resident alien during

the same tax year. The most common dual-status tax years are

the years of arrival and departure. Dual-status aliens are taxed

on income from all sources for the part of the year they are 

resident aliens. They are taxed only on income from U.S.

sources for the time they are nonresident aliens. They must file

Form 1040 and mark it “Dual Status Return” if they are resident

aliens on the last day of the tax year. If they are nonresident

aliens at the end of the year, they must file Form 1040NR and

mark it “Dual Status Return.” In either case, they must attach

a separate statement to explain their income and compute the

tax for the other part of their dual-status year. Dual-status aliens

must either itemize their allowable deductions or claim zero

deductions because they cannot use the standard deduction.

Lesson 4 4-3
4-4 Lesson 4

Exercise 1

Sgt. Zapata is stationed in Korea and is married to a Korean

citizen. Sgt. and Mrs. Zapata came to the United States for a 

3-week visit and returned to his post of duty in Korea. Mrs.

Zapata entered the United States on a non-immigrant visa.

a. What is Mrs. Zapata’s U.S. alien status?

Answer __________________________________________

b. If the Zapatas moved to the United States in June 2002 

and Mrs. Zapata got a green card, what would Mrs. Zapata’s

U.S. alien status be for 2002?

Answer __________________________________________

Exercise 2

Karen is a British citizen and a U.S. resident alien (green 

card holder). She married Lt. Trimble, a U.S. citizen, who has

a permanent residence in New York. The Trimbles moved to

Germany in 2001 for a 2-year tour of duty. They plan to return

to New York when his duty ends. Karen earned $12,000 a 

year working for a German employer while they were stationed

in Germany.

a. If Lt. Trimble files a separate return, does Karen have to 

file a U.S. federal tax return?

Answer __________________________________________

b. If the Trimbles were divorced in 2002 and Karen gave up 

her green card and moved to England, what would her U.S.

alien status be for 2002?

Answer __________________________________________

ALIEN MILITARY PERSONNEL

As a general rule, most alien enlistees in the Armed Forces are

resident aliens. This would almost certainly be true of an alien

who has lived in the United States before enlistment. In peacetime, the enlistment requirements of the Armed Services state

that no person may enlist unless that person is a citizen or has

been lawfully admitted to the United States for permanent residence under the immigration laws. These two factors, voluntary

enlistment and admittance for permanent residence, are usually

enough to classify an alien enlistee as a resident alien. The

United States has treaty agreements with certain nations that

LESSON 1
allow a very limited number of their citizens to retain their nonresident alien status. Alien enlistees in this category should

seek advice from their base legal officer. Other aliens who are

present in the United States merely because of military assignment and who have a residence outside the United States are

nonresident aliens.

CHOICE TO TREAT NONRESIDENT SPOUSE

AS A RESIDENT

A nonresident alien spouse may choose to be treated as a resident

alien if all the following conditions are met.

1. The nonresident alien spouse must be married to a U.S. citizen

or resident alien at the end of the tax year.

2. Both spouses must choose to treat the alien spouse as a 

resident alien.

3. One of the spouses must be a U.S. citizen or resident alien on

the last day of the tax year.

How to Make the Choice

A statement signed by both spouses must be attached to their

joint return for the first tax year for which the choice applies.

The statement should contain:

1. A declaration that one spouse was a nonresident alien and

the other spouse was a U.S. citizen or resident alien on the

last day of their tax year and that the nonresident alien

spouse chooses to be treated as a U.S. resident for the entire

tax year, and

2. The name, address, and social security number of each spouse.

If the nonresident alien spouse is not eligible to get a social

security number, he or she should file Form W-7, Application

for IRS Individual Taxpayer Identification Number.

Caution. Once the choice is made, the worldwide income of the

nonresident alien spouse is subject to U.S. tax. If the nonresident

alien spouse has substantial foreign income, there may be no

advantage to making the choice.

Ending the Choice

Once made, this choice applies to all later tax years unless one

of the following situations occurs.

■ Revocation—Either spouse may revoke the choice for any tax

year if both the choice and the revocation are made by the

due date for filing the tax return for that tax year.

Lesson 4 4-5
4-6 Lesson 4

■ Death—The death of either spouse will end the choice. This

ordinarily begins with the first year following the year in

which the spouse died. If the spouse who survived is a U.S.

citizen or resident and is entitled to the joint return rates as a

surviving spouse, the choice will not end until the close of the

last year for which these joint rates may be used.

■ Legal separation—A legal separation under a decree of

divorce or separate maintenance will end the choice beginning

January 1 of the tax year in which the legal separation occurs.

■ Inadequate records—The Internal Revenue Service can end

the choice for any year that either spouse fails to keep adequate tax records, to provide adequate access to those records,

or to supply other information reasonably necessary to determine the correct income tax liability.

If the choice is ended for any of these reasons, neither spouse

can make a choice for any future tax year. For example,

divorced individuals who previously made the choice and later

remarry cannot make another choice. 

Choice Not Made

If the choice is not made:

1. The nonresident alien spouse cannot file a joint return.

2. The nonresident alien spouse is generally not eligible for 

certain credits, such as the earned income credit or the 

education credits.

3. The spouse who is a U.S. citizen or resident may claim an

exemption for the nonresident alien spouse if the nonresident

alien has no gross income for U.S. tax purposes and is not

another taxpayer’s dependent. Check the box on line 6b of

Form 1040 or Form 1040A and write “NRA” to the right of

the word “spouse.”

4. The nonresident alien spouse does not have to file a federal

income tax return if he or she had no U.S. source income. 

He or she does not have to report any income from sources

outside the United States so long as he or she remains a 

nonresident alien. 

Questions concerning alien status and the special choice can be

complex. Further information can be found in Publication 519. 
Exercise 3

Stephen Rowan is a Navy officer who resides in New York and

is on duty in Japan. He has $30,000 in taxable income for the

year. His wife, to whom he has been married for 3 years, is a

Japanese citizen who has never visited the United States. She

earned $5,000 from employment in Japan during the year.

a. Is he required to file a U.S. income tax return?

Answer___________________________________________

b. Is Mrs. Rowan required to file a U.S. income tax return?

Answer___________________________________________

c. Can the Rowans file a joint return?

Answer___________________________________________

 SUMMING UP THIS LESSON 

Questions of alien status can be difficult. To find answers to

their questions and to learn whether they qualify for the option

to treat the nonresident spouse as a U.S. resident, military

personnel should see Publication 519, visit their base legal

office, or call the IRS at 1-800-829-1040.

Lesson 4 4-7

LESSON 1
4-8 Lesson 4

1. a. Nonresident alien

b. Dual-status alien

2. a. Yes. She is a resident alien.

b. Dual-status alien

3. a. Yes

b. No

c. Yes. They can make the choice, but they should figure their

tax both ways to determine which option is best for them. 

LESSON 4 ALIENS ANSWERS TO EXERCISES






OBJECTIVES

At the end of this lesson, you will be able to apply special rules

for the Head of Household status when the spouse was a nonresident alien.

INTRODUCTION

Many areas of the tax return are directly tied to the filing status of the taxpayer. Therefore, it is extremely important to

select the correct status and to apply the special rule if

applicable.

HEAD OF HOUSEHOLD (H OF H)

The rules can get a little more complex here and may cause

errors. In general, in order to claim H of H status, the taxpayer must be unmarried or considered unmarried on the last

day of the year and pay more than half the cost of keeping up a

home, for over six months, that includes the taxpayer and a

qualifying individual.

SPECIAL RULES

1. For H of H purposes, “you are considered unmarried if your

spouse was a nonresident alien at any time during the year,

and you do not choose to treat your spouse as a resident

alien” (Pub. 17). All of the other qualifications for H of H

must also be met.

Example

Raul is in the U.S. Army. His wife and children live in Japan.

His brother, who goes to high school in the U.S., lives with

Raul. Raul claims his brother as his dependent and maintains

the home. Even though Raul is married, he can claim H of H

status because of the special rule above. If Raul lived by himself, or shared living costs with friends, he would not benefit

from this rule and would have to file as a married person

(either as Married Filing Separate or Married Filing Joint).

Lesson 5 5-1

FILING STATUS 



LESSON 5




5-2 Lesson 5

2. Parents - The one exception to having a relative live with

the taxpayer concerns the taxpayer’s parents. “If your

dependent parent does not live with you, you must pay more

than half the cost of keeping up a home that was the main

home for the entire year for your mother or father...” (Pub.

17). The rules do not do not specify that the house the parents live in be in the United States. We’ve seen many

returns that claim the parents as dependents and also indicate that the parents live in Canada or Mexico, yet the filing

status is SINGLE. If the unmarried taxpayer, as part of

support, meets the maintenance of the house rules, and

claims the parents(s) as a dependent, the filing status

should be H of H.

Example

Manuel is a U.S. citizen. He is not married and is in the U.S.

military. His mother and father live in Mexico and he claims

them as a dependent on his tax return. He provides more than

have of the support of their household. Even though he is not

married and his parents do not live with him (or even live in

the U.S.), he can file as Head of Household.

Example

Gustav is a U.S. citizen and is in the U.S. military. He is not

married but he provides more than half of his mother’s support.

His mother is a citizen and resident of Germany. Gustav cannot claim his mother on his tax return because of the

Citizenship test. Since Gustav cannot claim his mother as his

dependent, he cannot file as Head of Household.

 SUMMING UP THIS LESSON 

 The taxpayer may be considered unmarried if the spouse

was a nonresident alien at any time during the year and

the taxpayer does not choose to treat the spouse as a

resident alien.

 If the taxpayer’s parent is claimed as a dependent, the

taxpayer may qualify for Head of Household filing status.
OBJECTIVE

At the end of this lesson, you will be able to apply the support

test and citizen or resident test to certain military situations.

INTRODUCTION

The Volunteer Assistor’s Guide explains the tests that must be

met before a person can be claimed as a dependent. In this lesson,

you will find more information about the support and citizen or

resident tests to help you assist members of the Armed Forces.

To claim an exemption for a dependent, taxpayers must provide a valid taxpayer identification number for their dependent

on their tax return. This is usually a social security number

(SSN) issued by the Social Security Administration. If the

dependent is not eligible to receive an SSN, taxpayers can

apply for an Individual Taxpayer Identification Number (ITIN)

by filing Form W-7.

If taxpayers do not provide a number or if they list an incorrect

number, the IRS may deny the exemption and bill them for

additional tax.

For 2002, the deduction for each personal or dependency

exemption is increased to $3,000.

Students Age 24 or Older

A taxpayer cannot claim an exemption for his or her child who

is a full-time student and has reached the age of 24 by the end

of the calendar year, even if all other dependency tests are

met, unless the student’s gross income is less than $3,000. If

his or her income is $3,000 or more, the student can claim his

or her own exemption. Remember, a person who can be claimed

as a dependent on another person’s return (for example, a

child eligible to be claimed on a parent’s return) cannot claim

his or her own personal exemption for that tax year. This is

true even if the other person does not actually claim the

dependency exemption.

Lesson 6 6-1

DEPENDENCY EXEMPTIONS

LESSON 6
6-2 Lesson 6

SUPPORT TEST

Armed Forces Member as a Dependent

A person who has been in the Armed Forces for the entire year

cannot be claimed as a dependent because the support test will

not have been met. A person in the Armed Forces for only part

of the year can be claimed as a dependent if all the dependency

tests are met. Amounts received from the Armed Forces that

are used for the person’s support must be taken into account.

If a person is appointed to one of the Armed Forces academies

and is at the academy all year, he or she cannot be a dependent. An appointee at the academy for only part of the year

may qualify as a dependent if all the tests are met.

Exercise 1

Kathleen Shannon is 18 and single. Kathleen graduated from

high school in June 2002 and entered the U.S. Air Force in

September 2002. Kathleen provided $3,400 (wages of $2,400

and $1,000 for other items provided by the Air Force) for her

own support, and her parents provided $3,600. Can Kathleen’s

parents claim a dependency exemption for her for 2002?

Answer ____________________________________________

Armed Forces Member Claiming a Dependent

If a member of the military has authorized a dependency allotment and the allotment is used to support dependents who did

not live with him or her for reasons other than divorce or separation, the member can claim exemptions for all of them if all the

dependency tests are met.

Example

Army Pvt. Gary Fairfield authorized a dependency allotment

for his mother. She used the amount received to support herself

and Gary’s 10-year-old sister. Gary provided no other funds for

their support. If the allotment provides more than half of their

total support for the year and all other dependency tests are

met, Gary can claim exemptions for both his mother and his

sister, even though the allotment was authorized for his mother

only. 
Exercise 2

Cpl. Jim Meigs authorized a dependency allotment for his 

son, John. The allotment ($150 a month) was in effect for all 

of 2002. How much support should Cpl. Meigs consider he 

provided for John in 2002?

Answer ____________________________________________

CITIZEN OR RESIDENT TEST

To meet the citizen or resident test, the taxpayer’s dependent

must be a U.S. citizen, a U.S. resident, or a resident of Canada

or Mexico for some part of the calendar year in which the taxpayer’s tax year begins.

Exercise 3

The wife of Col. William Banks is a Greek citizen. Her sister,

Athena, who is also a Greek citizen, lived in the Banks’ home

in Greece for the entire tax year. Col. Banks provided more

than 50% of Athena’s total support.

a. Can Col. Banks claim his sister-in-law as a dependent?

Answer __________________________________________

b. What would be your answer to (a) if Athena were a

Canadian citizen living in the Banks’ home in Greece for the

entire year?

Answer __________________________________________

If one parent of a child born in a foreign country is a U.S. citizen and the other parent is a nonresident alien, the child may

qualify as a U.S. citizen. The U.S. citizen parent must have

lived in the United States or its possessions for at least 5 years

before the child’s birth. Two of those years must have been

after the child reached age 14. Periods of honorable service in

the Armed Forces of the United States are counted as periods

of living in the United States. The parent who is a U.S. citizen

may claim the child’s dependency exemption if the child is a 

citizen, even though the child lives abroad with the nonresident

alien parent. The other dependency tests must, of course, be met.

Lesson 6 6-3
6-4 Lesson 6

A U.S. citizen who has legally adopted a child who is not a 

U.S. citizen or resident can claim the child as a dependent if the

other dependency tests are met and if, for the entire tax year:

1. The taxpayer’s home is the child’s main home, and

2. The child is a member of the taxpayer’s household.

Exercise 4

Sgt. John Racine, a U.S. citizen who has been in the U.S. Army

for 13 years, is stationed in Germany. His wife is a German

citizen who has never lived in the United States. Their 2-yearold son was born in Germany. Sgt. Racine’s stepdaughter, a

German citizen whom Sgt. Racine has not adopted, also lives

with them. The Racines provide total support for the two 

children. How many dependency exemptions can Sgt. Racine

claim on a joint return?

Answer ____________________________________________

 SUMMING UP THIS LESSON 

In this lesson you have learned how the support and citizen or

resident tests for the dependency exemption apply to some

military situations.

LESSON 1
1. Yes. The support test is met.

2. $1,800.

3. a. No. His sister-in-law was not a citizen or resident of the

United States at any time during the year.

b. No. Athena would have to reside in Canada for at least 

some part of the year to qualify.

4. One. The stepdaughter does not qualify as a U.S. citizen or

resident. The son qualifies because his father is a U.S. citizen.

Lesson 6 6-5

DEPENDENCY

EXEMPTIONS ANSWERS TO EXERCISES

LESSON 6
6-6 Lesson 6

STUDENT NOTES






OBJECTIVES

At the end of this lesson, you will be able to:

1. Determine if a taxpayer is entitled to claim a foreign spouse

or dependent on his or her tax return.

INTRODUCTION

This lesson discusses the special tax laws and filing procedures

that must be followed in order to prepare and file federal

income tax returns accurately for citizens or residents of the

United States who have spouses and/or dependents in Canada

or Mexico. The increasing amount of business with Canada

and Mexico, and our growing Hispanic population, make it

absolutely critical that volunteers know the tax and procedural

issues involved in filing these returns.

PERSONAL EXEMPTIONS

Generally, you are entitled to take one exemption for yourself

and one exemption for your spouse, if you file a joint return.

Your spouse is never considered your dependent. You may be

able to take an exemption for your spouse, even if they do not

live in the U.S.

If your spouse is a nonresident alien, he or she can choose to

file a joint return with you (see Lesson 4 for more information).

If the nonresident alien spouse makes this choice, they will be

treated like a resident alien for tax purposes. This means that

they will have to include all of their worldwide income on the

joint U.S. tax return. Your spouse does not have to be from

Canada or Mexico to make this choice.

Example 1

Pat Smith, a U.S. citizen, is married to Frank, a nonresident

alien. Pat and Frank make the choice to treat Frank as a resident alien by attaching a statement to their joint return. Pat

and Frank must report their worldwide income for the year

they make the choice and for all later years unless the choice is

ended or suspended. Although Pat and Frank must file a joint

return for the year they make the choice, they can file either

joint or separate returns for later years. If your nonresident

alien spouse does not choose to be treated as a resident alien,

Lesson 7 7-1

CLAIMING A FOREIGN

DEPENDENT OR SPOUSE 



LESSON 7




7-2 Lesson 7

you may be able to claim an exemption for the spouse on your

married filing separate return. Your nonresident spouse must

not have any gross income for U.S. tax purposes and cannot be

the dependent of another U.S. taxpayer. The spouse must have

a Taxpayer Identification Number (explained later in this lesson).

EXEMPTIONS FOR DEPENDENTS

You can also claim exemptions for dependents that qualify

under all of the dependency tests (see Lesson 6 for more information). The dependent must be a U.S. citizen or national or a

resident of the United States, Canada or Mexico for some part

of the calendar year.

Children are usually citizens or residents of the same country

as their parents. If you were a U.S. citizen when your child

was born, your child is generally a U.S. citizen. This is true

even if the other parent is a nonresident alien, the child was

born in a foreign country and the child lives abroad with the

other parent.

If you are a U.S. citizen living abroad and you have adopted a

child that is not a U.S. citizen or resident, you can claim an

exemption for the child as a dependent if your home is the

child’s main home and the child is a member of your household

for your entire tax year.

 SUMMING UP THIS LESSON 

 In general, you can claim an exemption for your nonresident alien spouse if he or she chooses to file a joint return

with you and be taxed as a resident alien.

 You can claim your nonresident alien spouse on your married filing separate return if your spouse has no income for

U.S. tax purposes and is not the dependent of another U.S.

taxpayer.

 You can claim nonresident dependents as long as they meet

all five dependency tests.

 Every person you claim on your return must have a

Taxpayer Identification Number.






OBJECTIVES

At the end of this lesson, you will be able to determine which

taxpayers need an Individual Taxpayer Identification Number.

INTRODUCTION

This lesson will discuss the Individual Taxpayer Identification

and its use. It will also discuss other entity issues associated

with federal income tax returns for those unable to obtain an

SSN.

NOTE: As this publication went to print, a task force was

studying various issues related to ITINs. The information provided in this publication was accurate at the time we went to

print. For the most current information, visit our website

www.irs.gov.

SOCIAL SECURITY NUMBERS

The Social Security Administration does not issue social security numbers to nonresident aliens unless they have legal permission to work in the United States. Social Security numbers

will be issued to lawful permanent residents. Canadians have

a number that is like a social security number, but it is for

their old age pension. Do not use this number on a U.S. tax

return. Canadians often have both a U.S. and Canadian Social

Security Number.

INDIVIDUAL TAXPAYER IDENTIFICATION

NUMBERS

An Individual Taxpayer Identification Number (ITIN) is a tax

processing number. The IRS issues an ITIN to individuals who

are required to have a U.S. taxpayer identification number

(TIN) but who do not have, and are not eligible to obtain an

SSN. An ITIN is a 9-digit number, beginning with the number

“9” and formatted like a SSN (XXX-XX-XXXX).

Lesson 8 8-1

TAXPAYER IDENTIFICATION

NUMBER AND OTHER

ENTITY ISSUES 



LESSON 8




8-2 Lesson 8

The ITIN is for tax purposes only. The issuance of an ITIN

does not:

• Entitle the recipient to Social Security benefits or the Earned

Income Tax Credit (EITC):

• Create an inference regarding the individual’s immigration

status:

• Give the individual the right to work in the U.S. Any individual who is legally eligible for employment in the U.S.

must have an SSN.

Who Needs An ITIN

If a taxpayer must file a U.S. tax return or is listed on a tax

return as a spouse or dependent, and does not have and cannot

obtain a valid SSN, the taxpayer must apply for an ITIN. IRS

regulations require a valid TIN on all U.S. federal income tax

returns. Each person listed on the return must have a valid

TIN.

The Procedure for Acquiring an ITIN

In general, to receive an ITIN the taxpayer files Form W-7 and

supplies documentation that will establish foreign status and

true identity. The W-7 and original documentation, or certified

copies, must be presented to and validated by the IRS.

Currently, this can be done in person at IRS taxpayer assistance centers or the papers can be submitted by mail to the

Philadelphia Processing Campus. It takes about six weeks for

the IRS to issue the numbers. (This process is currently under

review. It is possible that all ITIN applications will have to be

made in person in the future.)

UNDOCUMENTED (ILLEGAL) ALIENS

Undocumented aliens who meet the substantial presence test

(explained in lesson 4) are considered resident aliens for tax

purposes. They are not eligible for an SSN because they have

no legal work authorization. These aliens should apply for an

ITIN; however, the ITIN does not give them permission to

work.

A common scenario is that the undocumented alien “acquires”

(buys, trades etc.) an SSN to provide to their employer. The

employer hires the alien and gives them a W-2 at the end of the

year with the invalid SSN. The alien then files a tax return

with their ITIN listed as their identification number. This

causes a processing problem for the IRS. The refund will most

likely be held until the issue can be resolved. 

If the spouse of a U.S. citizen or resident is an illegal resident

alien, he/she should have an ITIN. Again, this would not give

the spouse permission to work.






CHILDREN BORN ABROAD

Military families living overseas who experience the birth of a

child in a host nation hospital or “off base on the economy”

should check with their base legal office or U.S. embassy officials for exact procedures for securing the Report of Birth

Abroad. This document serves as proof of citizenship and can

be used in the future. To formally register the birth of a child

born abroad, the U.S. citizen parent or parents should bring

the child to the Embassy/Consulate office along with:

• An original of the child’s birth certificate

• The parent’s marriage certificate

• Any divorce (original) decree or death certificate from any

previous marriage

• Cash or bank check to pay the fee (usually $65)

Parents should also apply for a passport for their child at the

same time as the Report of Birth. Along with your application

for Report of Birth and passport, it is also advisable to request

the form to apply for an SSN for the child. The Social Security

International Office in Baltimore, MD assigns an SSN. The

SSN will be mailed directly to you. The process takes several

months. But without an SSN the parents will NOT be able to

claim the EITC even if all of the other prerequisites are met.

OTHER ENTITY ISSUES

When you are completing the entity section of the tax return,

be careful to avoid some of the following common errors.

1. If you have selected the Married Filing Separate filing status, the spouse’s name should be listed on line 3 of the

return. Do not list the spouse’s name in the first section of

the return.

2. If you have selected the Head of Household filing status, be

sure that the qualifying individual is listed on the return.

This information will either appear on line 4 (if the qualifying person is the taxpayer’s child and not their dependent)

or it will appear on line 6c, the area where you list dependents.

3. If you have selected the Married Filing Joint filing status, be

sure that both spouse’s names and identification numbers

appear at the top of the return. Also be sure that both

spouses sign the return. 

Lesson 8 8-3




8-4 Lesson 8

 SUMMING UP THIS LESSON 

 All taxpayers and dependents listed on a tax return must

have an identification number.

 An Identification Number can be either a SSN or an ITIN.

 Use caution when completing the entity section of the tax

return.

LESSON 1






INTRODUCTION

Generally, a U.S. citizen or resident alien is taxed on their

world-wide income. This can lead to a situation where the taxpayer is paying tax twice on the same income – once to the foreign government and to the U.S. government. The foreign tax

credit was created to help alleviate this situation. You do not

have to live abroad to qualify for the credit.

OBJECTIVES

At the end of this lesson, you will be able to:

1. Determine which types of taxes qualify for the foreign tax

credit.

2. Correctly complete a Form 1116.

3. List what types of income qualify for the credit.

WHAT TYPES OF TAXES QUALIFY FOR THE CREDIT

The taxpayer must have income from a foreign country on

which he or she is taxed by a foreign country. The tax imposed

on the income must be similar to the income tax imposed in the

U.S.

Example 1

Robb and Betty Grant are U.S. citizens who are on TDY in

France. They have $500 of interest income from a U.S. bank.

They also have $600 of interest income from a French bank.

They are required to pay taxes in France on the interest they

earned there. On their U.S. tax return, they can compute a foreign tax credit against the taxes that they pay to the U.S. on

the interest earned in France.

If the tax imposed by the foreign country is considered a payment for a specific economic benefit, it does not qualify for the

credit. For example, real estate taxes paid to a foreign government do not qualify for the credit.

Example 2

Marie Elliott is a U.S. citizen who lives in Hong Kong. She is

the fiancée of one of the men in your unit. You are trying to

help her with her returns. She owns a house in Hong Kong and

paid $2,000.00 in real estate taxes for her home and $1,000.00

Lesson 9 9-1

FOREIGN TAX CREDIT 



LESSON 9




9-2 Lesson 9

in personal property taxes. She also paid $300.00 in income

taxes to the government of Hong Kong. She is not able to claim

the foreign tax credit on either the real estate taxes or personal

property taxes paid. Income taxes are the only type of tax that

qualifies for the foreign tax credit. You can use the $300.00 of

income tax to compute her foreign tax credit. (Note – If she

itemizes, she can deduct the real estate taxes. The personal

property tax would only be deductible if it is related to the production of income.)

Country Restrictions. There are also certain countries to

which a taxpayer may pay foreign taxes but cannot claim a foreign tax credit. Generally, the reason a credit may not be

claimed for tax paid to one of these countries is because the

Secretary of State has designated the country as one that

repeatedly provides support for acts of international terrorism.

The credit can also be denied to countries with which the

United States has no diplomatic relations or countries whose

government the U.S. does not recognize. Income taxes paid to

the following countries are not eligible for the foreign tax

credit:

CUBA

IRAN

IRAQ

LIBYA

NORTH KOREA

SYRIA

SUDAN

Example 3

Ralph, an armed forces member, is a U.S. citizen who has

investments in both Belgium and Iran. On these investments

Ralph pays income tax in the foreign countries. Ralph can

claim the taxes paid to Belgium in computing his foreign tax

credit. The taxes paid to Iran do not qualify for the credit.

WHAT TYPES OF INCOME QUALIFY FOR THE CREDIT?

The tax paid on the following types of income can qualify for

the foreign tax credit:

Passive Income

High withholding tax interest

Financial services income

Shipping income

Dividends from a DISC or former DISC






Certain distributions from a foreign sales corporation or

former foreign sales corporation 

Lump-sum distributions

Section 901(j) income

Certain income re-sourced by treaty

General limitation income

A separate Form 1116, Foreign Tax Credit, must be completed

for each category of income. The income items listed in bold

type above are the most common. They are more fully

explained below.

Passive Income. Passive income generally includes the following types of income: dividends, interest, royalties, rents and

annuities. If you are assisting a taxpayer who has one (or more)

of these types of passive income from a foreign country, and he

or she paid taxes to a foreign country, you should compute the

foreign tax credit. If the foreign tax paid on the passive income

exceeds 38.6%, the passive income category is not used. The

appropriate classification for this type of income is the general

limitation category.

Example 4

Darlene, a U.S. army employee, has a bank account in

Venezuela, where her mother lives. In 2002, she received $3800

in interest income for the Venezuelan bank. She had to pay

$380 of income tax to the Venezuelan government. She is not

filing a joint return. She will need to attach form 1116 to her

U.S. income tax return. The “passive income” category should

be marked.

High Withholding Tax Interest. Certain interest income is

not included in the passive income category. If the taxpayer you

are helping had interest income on which at least 5% foreign

gross income tax was withheld, then this is classified as high

withholding tax interest and not passive income.

Example 5

Regina has been a member of your unit for two years. She is

single and a U.S. citizen. She maintains a bank account in

Singapore where she used to live. In 2002, the foreign bank

withheld 15% of her interest income for income taxes. This falls

into the category of “high withholding tax interest” on form

1116, even though it is passive income.

General Limitation Income. The final income category on

form 1116 is the “general limitation income” category. If the

person you are helping has foreign income that does not come

under any of the other categories on Form 1116, then that foreign income comes under the general limitation income cateLesson 9 9-3




9-4 Lesson 9

gory. Most often, this would be wages earned in a foreign country that an individual does not exclude under the foreign

earned income exclusion (Lesson 2).

If the person you are assisting has passive income which is

taxed by a foreign government at a rate that is higher than the

highest U.S. income tax rate, then the foreign tax credit for

that income would be computed under the general limitation

category.

Example 6

Siegfried has been your best friend since third grade. He is a

U.S. citizen who now lives and works in Switzerland. He does

not elect to take the foreign earned income exclusion. He can

claim a foreign tax credit for the taxes paid on his earnings to

the Swiss government. You tell him that he should mark the

“general limitation income” category on his Form 1116.

COMPLETING FORM 1116

The rest of this lesson is dedicated to the mechanics of completing Form 1116, Foreign Tax Credit. You will see that some of

the lines on the form are considered to be beyond the scope of

the VITA/TCE program. The provided instructions assume that

you are completing the form by hand. Many tax software packages (including TaxWise®) will assist you in determining how

to complete the form.

You should also keep in mind that Form 1116 is not required if

the total Foreign Tax Credit is less than $300 per taxpayer and

only qualified passive foreign sourced income is involved. When

this exception applies, the taxpayer can claim the credit without attaching the form.




Lesson 9 9-5

Draft as of

6/25/2002

OMB No. 1545-0121 Foreign Tax Credit

Form 1116 (Individual, Estate, or Trust)

Department of the Treasury

Internal Revenue Service

 Attach to Form 1040, 1040NR, 1041, or 990-T. Attachment

 See separate instructions. Sequence No. 19

Name Identifying number as shown on page 1 of your tax return

Passive income Lump-sum distributions

High withholding tax Dividends from a DISC or former DISC

interest

Financial services income General limitation income

Certain distributions from a foreign

sales corporation (FSC) or former

FSC

Resident of (name of country) 

Note: If you paid taxes to only one foreign country or U.S. possession, use column A in Part I and line A in Part II. If you paid taxes to

more than one foreign country or U.S. possession, use a separate column and line for each country or possession.

Taxable Income or Loss From Sources Outside the United States (for Category Checked Above)

Foreign Country or U.S. Possession Total

A B C (Add cols. A, B, and C.)

Enter the name of the foreign country or U.S.

possession 

Gross income from sources within country

shown above and of the type checked above (see

page 7 of the instructions):

1

1

Deductions and losses (Caution: See pages 9, 12, and

13 of the instructions):

2 Expenses definitely related to the income on

line 1 (attach statement)

3 Pro rata share of other deductions not definitely

related:

Certain itemized deductions or standard

deduction (see instructions)

a

b Other deductions (attach statement)

c Add lines 3a and 3b

d Gross foreign source income (see instructions)

e Gross income from all sources (see instructions)

f Divide line 3d by line 3e (see instructions)

g Multiply line 3c by line 3f

4 Pro rata share of interest expense (see instructions):

a Home mortgage interest (use worksheet on

page 12 of the instructions)

b Other interest expense

5 Losses from foreign sources

6 Add lines 2, 3g, 4a, 4b, and 5 6

7 Subtract line 6 from line 1. Enter the result here and on line 14, page 2  7

Foreign Taxes Paid or Accrued (see page 13 of the instructions)

Credit is claimed Foreign taxes paid or accrued for taxes

(you must check one) In foreign currency In U.S. dollars

Paid (s) Other

foreign taxes

paid or

accrued

(w) Other

foreign taxes

paid or

accrued

(x) Total foreign

taxes paid or

accrued (add cols.

(t) through (w))

Taxes withheld at source on: Taxes withheld at source on: Accrued

Country

(q) Rents

and royalties

(u) Rents

and royalties

(o) Date paid

or accrued (p) Dividends (r) Interest (t) Dividends (v) Interest

A

B

C

8 Add lines A through C, column (x). Enter the total here and on line 9, page 2  8

For Paperwork Reduction Act Notice, see page 16 of the instructions. Form 1116 (2002)

Shipping income

Cat. No. 11440U

Part I

Part II

a

b

c

d

e

g

h

i

k

(m)

(n)

l

Use a separate Form 1116 for each category of income listed below. See Categories of Income on page 3 of the instructions. Check only one

box on each Form 1116. Report all amounts in U.S. dollars except where specified in Part II below.

f

Section 901(j) income

j

Certain income re-sourced by treaty

(99)

2002




9-6 Lesson 9

Draft as of

6/25/2002

Form 1116 (2002) Page 2

Figuring the Credit

9 Enter the amount from line 8. These are your total foreign taxes paid

or accrued for the category of income checked above Part I 9

10 Carryback or carryover (attach detailed computation) 10

11 Add lines 9 and 10 11

12 Reduction in foreign taxes (see page 13 of the instructions) 12

13 Subtract line 12 from line 11. This is the total amount of foreign taxes available for credit 13

14 Enter the amount from line 7. This is your taxable income or (loss) from

sources outside the United States (before adjustments) for the category

of income checked above Part I (see page 14 of the instructions) 14

15 Adjustments to line 14 (see page 14 of the instructions) 15

16 Combine the amounts on lines 14 and 15. This is your net foreign

source taxable income. (If the result is zero or less, you have no foreign

tax credit for the category of income you checked above Part I. Skip

lines 17 through 21. However, if you are filing more than one Form

1116, you must complete line 19.)

Individuals: Enter the amount from Form 1040, line 39. If you are a

nonresident alien, enter the amount from Form 1040NR, line 37.

Estates and trusts: Enter your taxable income without the deduction

for your exemption

17

17

18 Divide line 16 by line 17. If line 16 is more than line 17, enter “1” 18

Individuals: Enter the amount from Form 1040, line 42. If you are a nonresident alien, enter the

amount from Form 1040NR, line 40.

19

19

20 Multiply line 19 by line 18 (maximum amount of credit) 20

Enter the smaller of line 13 or line 20. If this is the only Form 1116 you are filing, skip lines 22 through

30 and enter this amount on line 31. Otherwise, complete the appropriate line in Part IV (see page

15 of the instructions) 

21

21

Summary of Credits From Separate Parts III (see page 16 of the instructions)

22 Credit for taxes on passive income 22

23 Credit for taxes on high withholding tax interest 23

24 Credit for taxes on financial services income 24

25 Credit for taxes on shipping income 25

26

Credit for taxes on dividends from a DISC or former DISC and certain

distributions from a FSC or former FSC

26

27

Credit for taxes on certain income re-sourced by treaty

27

28

Credit for taxes on lump-sum distributions

28

29 Credit for taxes on general limitation income 29

30 Add lines 22 through 29 30

32 Reduction of credit for international boycott operations. See instructions for line 12 on page 13 32

33 Subtract line 32 from line 31. This is your foreign tax credit. Enter here and on Form 1040, line 45;

Form 1040NR, line 43; Form 1041, Schedule G, line 2a; or Form 990-T, line 40a  33

Part IV

Part III

Caution: If you figured your tax using the special rates on capital gains, see page 15 of the instructions.

16

Estates and trusts: Enter the total of Form 1041, Schedule G, lines 1a and 1b, or the total of Form 990-T,

lines 36 and 37

Form 1116 (2002)

31 Enter the smaller of line 19 or line 30 31






Part 1 – Taxable Income

This part of the form is used to figure the taxable income from

foreign sources in each country. You will note that there is room

for up to 3 countries to be listed. If the taxpayer paid foreign

taxes to more than 3 countries, an additional Form 1116 will be

needed. Also, remember that only one type of foreign income

can be reported on each Form 1116.

On the first line in Part 1, list the name of the foreign country.

On line 1, enter all of the foreign income that fits under the

category checked at the top of the form. Be sure to list that

income separately for each country. Total the three columns

and put the figure on line 1 in the “Total” column (on the far

right of the form).

Lines 2-5 in Part 1 are more challenging. Therefore, several

of the lines or situations are considered to be outside of the

scope of the VITA/TCE program. We will not cover the following

items:

Line 2 – Expenses directly related to the income on

Line 1. If the person you assisting has expenses that are

related directly to the income on line 1, such as employee

business expenses, and the income claimed on line 1 was

earned income, you should tell the taxpayer to seek professional tax assistance.

Line 4 – Interest Expense. If the taxpayer borrowed

money in order to purchase investment property, such as

stock, then some allocations may need to be done. You

should tell the taxpayer to seek professional tax assistance.

Other interest expense that is related to the foreign sourced

income will require allocations. Again, the taxpayer should

seek professional tax assistance.

Line 5 – Foreign Losses. If the person you are helping

had any type of foreign losses, such as net losses from selling capital assets, they should seek professional tax assistance.

Line 3. You will complete line 3a if you completed a Schedule A

(Itemized Deductions) for the person you are assisting. The

total of the itemized deductions (except for qualified residence

and personal interest) not directly related to foreign income

from line 26 of Schedule A is entered on line 3a. If the taxpayer

does not itemize, the standard deduction should be entered on

line 3a.

Line 3b is considered to be outside of the scope of the

VITA/TCE program. Taxpayers who need to make entries on

this line should seek professional tax assistance. Therefore, for

returns that you are preparing, line 3c should be the same as

line 3a.

Lesson 9 9-7




9-8 Lesson 9

All income from foreign sources in the category checked at the

top of Form 1116 is listed on line 3d. If the foreign earned

income exclusion was claimed and the Form 1116 is for the general limitation category, then the amount of the claimed exclusion is entered here as well. Under most circumstances, line 3d

will be the same as line 1.

Line 3e is gross income from all sources. Usually, this line will

be the same as line 22 of the Form 1040. If the foreign income

exclusion was claimed, then the amount of the exclusion must

be added on this line.

Lines 3f and 3g are mathematical. If you are not using tax software to prepare the return, be sure to check your math on

these lines.

Line 6 will be the same as line 3g on the returns you prepare.

(Remember that the VITA/TCE programs do not cover lines 2, 4

and 5.)

On line 7, subtract line 6 from 1. Put the answer in the “Total”

column on line 7. Also put the amount on line 14 of Form 1116.

Part II – Foreign Taxes Paid or Accrued.

Part II of form 1116 covers the computation of foreign taxes

paid or accrued on the foreign income. Even though most taxpayers are considered to be on the cash basis, they can choice

to calculate the foreign tax credit using the accrual basis.

Many foreign countries have a different tax system from the

U.S. In some cases, the individual simply reports his or her

taxable income and the government involved computes the tax

and bills the taxpayer. In other instances, taxpayers may make

in one year for income made in the previous year. ( In these

instances, a cash basis taxpayer may wish to use the accrual

basis for calculating the foreign tax credit.)

On Part II of the Form 1116, you must indicate if the credit is

being claimed for foreign taxes actually paid in 2002 or if it is

being claimed on foreign taxes accrued in 2002. Part II also has

two separate sections in which you indicate the amounts withheld, paid or accrued in the foreign currency and then convert

these amounts to U.S. dollars.

One of the questions that frequently arises is what currency

exchange rate should be used. If you are using the cash basis,

then the exchange rate that is the most accurate for the date of

the payment should be used. If the taxpayer you are assisting

had foreign taxes withheld throughout the year, then you can

use the annual average exchange rate. Exchange rates can usually be obtained from major international banks and international currency exchanges. If the taxpayer you are assisting is






using the accrual method to calculate the foreign taxes paid,

you must generally use the average exchange rate for the tax

year.

Total foreign taxes paid or accrued should be listed in column x.

The total of all three lines in column x should be entered on

line 8. This completes page 1 of Form 1116.

Part III – Figuring the Credit

Part III of the form 1116 is the actual computation of the

Foreign Tax Credit. Below are line-by-line instructions for this

part of the form.

Line 9. This is the same as line 8.

Line 10. This is beyond the scope of the VITA/TCE program. If

the taxpayer you are assisting has a carry back or carryover of

unused foreign tax credit, they should seek professional tax

assistance.

Line 11. This is a total of lines 9 and 10. Since you will not be

completing line 10, line 11 should be the same as line 9.

Line 12. A reduction to the foreign taxes paid or accrued has to

be made under certain circumstances. One of the most common

situations is the reduction for taxes allocable to income

excluded under the foreign earned income exclusion. Use the

following formula to determine the amount to enter on line 12.

Excluded Foreign Earned Income

Total Foreign Income X Foreign Tax = Reduction

Any other type of reduction that may need to be entered on line

12 is beyond the scope of the VITA/TCE program.

Line 13. This is a mathematical computation. The answer represents the amount of foreign taxes which is still eligible for

the credit computation.

Line 14. If you have not already entered the amount from line

7 in Part l of the form, do so now.

Line 15. This line is considered to be beyond the scope of the

VITA/TCE program. Taxpayers who feel that they need to enter

an amount on line 15 should seek professional tax assistance.

Line 16. For the returns that you prepare, this will be the

same as line 14 (which is the same as line 7).

Line 17. Enter the amount from line 37 of Form 1040.

Line 18. This is a mathematical line. Carry your answer to

four decimal points. If line 16 is larger than line 17, then enter

the whole number 1 on this line.

Lesson 9 9-9




9-10 Lesson 9

Line 19. Enter the amount from line 40 of the U.S. Form 1040

less any amounts on Line 41 and 42 of Form 1040.

Line 20. Again, this is a mathematical line.

Line 21. Compare the amounts on lines 13 and 20. Enter the

smaller of the two amounts on line 21.

If you only have to complete one form 1116 for the taxpayer,

enter the amount from line 21 on lines 29 as well as 31.

Part IV – More than one Form 1116

Part IV of the Form 1116 is used as a summary of the foreign

tax credit. You will need to complete this section if you complete more than one form 1116 for the taxpayer. You complete

Part IV on only one of the multiple forms 1116 that you are

attaching to the return. It does not matter which of the forms

1116 you use. You would indicate in Part IV of the summary

Form 1116 the amount of the credit computed on line 21 of Part

iii from each Form 1116. Line 30 is a total of all Forms 1116.

Since line 32 is beyond the scope of the VITA/TCE program,

enter the amount from line 30 on line 32. 

ITEMIZED DEDUCTION VS. CREDIT

The taxpayer may choose to claim the amount of foreign taxes

paid as an itemized deduction rather than a tax credit. The taxpayer cannot claim both an itemized deduction and tax credit

on the same foreign tax. Taxpayers who receive a deduction on

their state returns for federal itemized deductions may consider

claiming their foreign tax as an itemized deduction rather than

a credit. However, in most cases, the credit will provide a better

benefit on the federal return.






 SUMMING UP THIS LESSON 

 In order to qualify for a foreign tax credit, income on which

the taxes are paid must be foreign source.

 The tax being paid must be similar to U.S. income tax.

 The individual paying the tax cannot derive a specific economic benefit from the tax paid.

 The foreign tax credit is computed on Form 1116.

 Form 1116 is not required if the foreign tax credit is less

than $300 per taxpayer and all of the income is from passive sources.

 A separate Form 1116 must be completed for each type of

income. Only one income category can be marked on each

form 1116.

 If passive income is subject to tax at a rate that is higher

than 38.6%, then it falls into the general limitation

category.

 A cash basis taxpayer may calculate the credit based on

the actual foreign taxes paid or accrued.

 If there is more than one Form 1116 for the same person,

Part IV only needs to be completed on one of the forms.

 For additional information and examples, refer to publication 514, Foreign Tax Credit for Individuals.

Lesson 9 9-11
9-12 Lesson 9

STUDENT NOTES
OBJECTIVE

At the end of this lesson you will be able to determine a person’s

eligibility for the earned income credit.

INTRODUCTION

The Volunteer Assistor’s Guide gives the basic requirements 

of the earned income credit. In this lesson you will see how

the earned income credit affects members of the military. In

particular, you will learn how military members who are stationed outside the United States may qualify for the earned

income credit. The credit amount has increased and is available to taxpayers who have both earned income and adjusted

gross income (AGI) less than $29,201 ($30,201 if married filing

jointly) if they have one qualifying child or $33,178 ($34,178 if

maried filing jointly) if they have two or more qualifying children. The credit is also extended to some taxpayers who earn

under $11,060 ($12,060 if married filing jointly) and do not

have a qualifying child.

CAUTION

Any taxpayer who fraudulently claims the EIC is ineligible to

claim the credit for a period of 10 years. In addition, a taxpayer

who erroneously claims the EIC by a reckless or intentional

disregard of rules or regulations is ineligible to claim the credit

for two years. These sanctions are in addition to any other

penalty imposed by law.

If the earned income credit was disallowed as a result of deficiency procedures, taxpayers cannot claim the credit again unless

Form 8862, Information To Claim Earned Income Credit After

Disallowance, is attached to the return; if the credit is claimed

without attaching Form 8862, it will be automatically denied.

A deficiency procedure occurs when the IRS questions the taxpayer’s eligibility for the earned income credit for reasons other

than a mathematical or clerical error. If the credit was disallowed because of a mathematical or clerical error, Form 8862

should not be completed. For more information on deficiency

procedures, see Publication 596, Earned Income Credit.

Lesson 10 10-1

EARNED INCOME CREDIT

LESSON 10
10-2 Lesson 10

EARNED INCOME CREDIT

The earned income credit is a refundable tax credit for certain

workers. A refundable credit can be greater than the tax on 

the taxpayer’s income. If the credit is greater than the tax, the 

taxpayer will receive a refund of the excess credit amount. 

For a detailed discussion of the rules and an explanation of the

earned income credit, see Publication 596.

Eligibility

In order to take the credit, taxpayers must meet all of the 

following rules:

1. They must have taxable earned income during the year.

2. Their earned income and AGI must both be less than

$29,201 ($30,201 if married filing jointly) if they have one

qualifying child, $33,178 ($34,178 if married filing jointly)

if they have two or more qualifying children, or $11,060

($12,060 if married filing jointly) if they have no qualifying

children. Eligible taxpayers without a qualifying child must

be at least age 25 and under age 65 at the end of the tax

year and cannot be eligible to be a dependent on another

person’s return.

3. A qualifying child must live with them in the United States

for more than half the year. Eligible taxpayers without a

qualifying child must have their main home in the U.S. for

more than half the year. See Residency Test, later, for an

exception for taxpayers stationed overseas on extended

active duty. 

4. They must provide a social security number (SSN) issued 

by the Social Security Administration for themselves, their

spouse (if married), and each qualifying child. The taxpayers cannot use an SSN if it was issued solely to apply for or

receive federally funded benefits or if “Not valid for employment” is on the card. Additionally, the child cannot have an

ITIN (Individual Taxpayer Identification Number) or ATIN

(Taxpayer Identification Number for Pending Adoptions).

Note: If the taxpayers do not provide correct and valid

SSNs, the IRS may deny the credit and bill them for additional tax, penalties, and interest.

5. Their filing status can be any filing status EXCEPT married

filing a separate return. Most married taxpayers must file a

joint return to get the credit. However, see Married taxpayers living apart, later, for an exception to the joint return

rule.

6. They cannot be a qualifying child of another person.
7. They usually must claim as a dependent a qualifying child

who is married.

8. They did not file Form 2555, Foreign Earned Income, or

Form 2555-EZ, Foreign Earned Income Exclusion, to

exclude from gross income any income earned in foreign

countries, or deduct or exclude a foreign housing amount.

See Publication 54, Tax Guide for U.S. Citizens and

Resident Aliens Abroad, for more information.

9. They must be a U.S. citizen or resident. Nonresident

aliens may qualify for the credit only if they are married

to a U.S citizen or resident and agree to be treated as

U.S. residents. If the nonresident alien spouse filed a joint

return using an ITIN, the couple is not eligible for the

credit. See Choice to Treat Nonresident Spouse as a

Resident in Lesson 4.

10. They cannot have more than $2,550 in investment income

during the year. For most people, investment income is taxable interest and dividends, tax-exempt interest, and capital gain net income.

Use the eligibility questions to determine if the taxpayer can

claim the earned income credit. The questions are found in the

forms instructions (line 8, Form 1040EZ, line 41, Form 1040A,

and line 64, Form 1040). After answering the questions, complete the Earned Income Credit (EIC) Worksheet. Completion of

the EIC Worksheet is dependent upon completion of the eligibility questions. Do not attach either the eligibility questions or the

EIC Worksheet to the return.

Married taxpayers living apart. Married taxpayers usually

must file a joint return to claim the earned income credit. Even

though a taxpayer is married, he or she can file as head of

household if:

1. The taxpayer’s spouse did not live in the taxpayer’s home at

any time during the last 6 months of the year,

2. The taxpayer paid more than half the cost to keep up the

home for the entire year, and

3. The child and the taxpayer lived in the same main home for

more than half the year and the child is the taxpayer’s

dependent. If the taxpayer cannot claim the qualifying child

as a dependent because he or she signed an agreement giving the exemption to the other parent or if a pre-1985 agreement grants the exception to the other parent, the taxpayer

will still meet the requirements for the EIC.

Lesson 10 10-3
10-4 Lesson 10

QUALIFYING CHILD

Taxpayers have a qualifying child if the child meets three tests:

■ Relationship,

■ Residency, and

■ Age.

Relationship test

To meet the relationship test, the qualifying child must be one

of the following:

1. Son, daughter, adopted child, stepson, stepdaughter or a

descendant of the taxpayer’s son, daughter, adopted child,

stepson, or stepdaughter.

2. Brother, sister, stepbrother, stepsister or a descendant of

the taxpayer’s brother, sister, stepbrother, or stepsister,

who the taxpayer cares for as his or her own child.

3. Eligible foster child.

An eligible foster child is any individual that is not described

in number 1 or 2, above who has been placed with the taxpayer

by an authorized placement agency and who the taxpayer cares

for as his or her own child.

A married child must also be the taxpayer’s dependent.

However, if the taxpayer cannot claim the married qualifying

child as a dependent because he or she signed an agreement

giving the exemption to the other parent or if a pre-1985 agreement grants the exemption to the other parent, the married

child will be considered to have met the relationship test.

Residency test

To meet the residency test, the qualifying child must live in the

same home with the taxpayer in the United States for more

than half the year.

Exception: For determining whether a qualifying child meets

the residency test, during any time a taxpayer is stationed 

outside the U.S. on extended active duty (more than 90 days 

or indefinitely), the taxpayer is considered to be maintaining

a residence in the U.S.

Birth or death of a child. Taxpayers will meet the rule for

a child living with them for more than half the year if:

■ The child was born or died during the tax year, and

■ The child lived with the taxpayer for the entire time the

child was alive.

LESSON 1
Temporary absences. The taxpayer will meet the residency

test if the taxpayer or the qualifying child is away from home

on a temporary absence due to a special circumstance.

Examples of a temporary absence include:

■ Illness,

■ Attending school,

■ Detention in a juvenile facility,

■ Business,

■ Vacation, or

■ Military service.

Note: The taxpayer may be eligible for the earned income credit

if absent temporarily only because of military service. To be eligible for the credit, the taxpayer must plan to return to the home

where the taxpayer’s qualifying child lives at the end of the

assignment. Service in a combat zone is a temporary absence.

Exercise

Cpl. Graves is stationed in Japan. After his tour of duty, he

intends to return to the United States where his wife and 

6-month-old daughter (qualifying child) live. The Graves will

file a joint return. Does he meet the residency test?

Answer __________________________________________

Age test. The age test is met if the taxpayer’s child is:

■ Under age 19 at the end of the year,

■ A full-time student who is under age 24 at the end of the

year, or

■ Permanently and totally disabled at any time during the tax

year, regardless of age. 

Qualifying child of more than one taxpayer

Beginning with tax year 2002, if a child is a qualifying child of

more than one taxpayer, the taxpayers may choose which of

them will claim the credit on the basis of that child. Review

Publication 678, Lesson 10, for additional information.

Lesson 10 10-5
10-6 Lesson 10

EARNED INCOME

Earned income for purposes of the earned income credit is

defined as wages, salaries, tips, and other employee compensation (but only if includible in gross income for the tax year),

plus net earnings from self-employment. (Employee compensation that is not currently taxable is not considered earned

income for purposes of figuring the earned income credit.)

Earned income includes:

■ Wages, salaries, tips,

■ Taxable long-term disability benefits the taxpayer receives

prior to minimum retirement age,

■ Taxable pay for service in a combat zone, and

■ Net Earnings from self-employed.

Earned income does not include:

■ Interest and dividends,

■ Social security benefits,

■ Pensions or annuities,

■ Veterans’ benefits,

■ Workers’ compensation benefits,

■ Alimony,

■ Child support,

■ Nontaxable foster care payments,

■ Unemployment compensation,

■ Variable housing allowance,

■ Salary deferrals,

■ Quarters and subsistence allowances and in-kind quarters

and subsistence received by military members,

■ Excludable pay for service in a combat zone,

■ Workfare payments from state or local welfare agencies.

Note: Workfare payments are cash payments low-income taxpayers receive from a state or local agency that administers

public assistance programs funded under the Federal Temporary

Assistance for Needy Families (TANF) program. These payments

are for:

■ Work experience activities (including remodeling or repairing

public housing) if sufficient private sector employment is not

available, or

■ Community service program activities.
ADVANCE EARNED INCOME CREDIT

If taxpayers expect to qualify for the earned income credit for

2003, they can choose to receive part of the credit regularly in

their pay. They should fill out the 2003 Form W-5, Earned

Income Credit Advance Payment Certificate, and give it to their

appropriate finance office. Only persons eligible for the credit

who have a qualifying child can receive advance payments. 

Lesson 10 10-7
10-8 Lesson 10

Yes. He is temporarily absent because of military service.

 SUMMING UP THIS LESSON 

In this lesson, you have learned how the earned income credit

rules apply to some military situations. This refundable credit,

which can be greater than the tax, is claimed on Form

1040EZ, Form 1040A or Form 1040.

EARNED INCOME CREDIT

LESSON 10 ANSWER TO EXERCISE
OBJECTIVE

At the end of this lesson you will be able to determine if a taxpayer who sells a main home qualifies to exclude all or part of

any gain from his or her income.

INTRODUCTION

This lesson generally discusses tax rules that apply when a

taxpayer sells his or her main home in 2002. For more detailed

discussion get Publication 523, Selling Your Home.

Gain. If the sale of a main home results in a gain, the taxpayer

should follow the rules discussed below. See also, Publication

523 and Lesson 13 of the Volunteer Assistor’s Guide. The taxpayer cannot deduct a loss from the sale of a main home.

Form 1099-S. If the taxpayer receives a Form 1099-S, Proceeds

From Real Estate Transactions, the date of sale is shown in box

1. If a form was not received, the date of sale is the earlier of

(a) the date title transferred or (b) the date the economic burdens and benefits of ownership shifted to the buyer. In most

cases, these dates are the same. Form 1099-S, box 2, shows the

gross proceeds the taxpayer received on the sale.

If a taxpayer sold or exchanged a main home in 2002, he or she

may qualify to exclude all or part of any gain from his or her

income. The qualified homeowner will not have to pay tax on

the gain up to the limit described next, under Amount of

Exclusion. To qualify for this exclusion, the ownership and use

tests, described later, must be met.

Amount of Exclusion. A single homeowner can generally

exclude up to $250,000 of gain from the sale of his or her main

home. A married couple can exclude up to $500,000 if they meet

all the following conditions.

a. A joint return is filed for the married couple for the year.

b. Either spouse or both meet the ownership test.

c. Both individuals meet the use test.

d. Neither spouse excluded gain from the sale of another home

in the 2 years before the current sale of home.

Lesson 11 11-1

SALE OF HOME

LESSON 11
11-2 Lesson 11

For married individuals filing jointly who do not qualify for the

$500,000 exclusion of gain on the sale of a home because they

do not satisfy the two-year ownership test, two-year use test,

and the prohibition on any other sale or exchange of a residence within the last two years, the limit on the amount of

excludable gain should be calculated separately for each

spouse. In that case, the maximum exclusion for the couple is

equal to the sum of the exclusions to which the spouses would

otherwise be entitled if they had not been married.

Ownership and Use Tests. The exclusion is allowed each

time a taxpayer sells or exchanges his or her principal residence, but generally no more frequently than once every two

years. To be eligible, the property must have been:

OWNERSHIP TEST

1. Owned and used as the taxpayer’s main home for a combined

period of at least 2 years out of a 5-year period ending on the

date of the sale or exchange.

USE TEST

2. Lived in as a main home for at least 2 years of that 5-year

period.

Period of ownership and use. The required 2 years of ownership and use (during the 5-year period ending on the date of

the sale) do not have to be continuous. Taxpayers can meet the

tests if they can show that they owned and lived in the property as their main home for either 24 full months or 730 days

(365 x 2) during the 5-year period. Short temporary absences

for vacations or other seasonal absences (even if the property is

rented out during the absences) are counted as periods of use.

If the property was owned and used as a main home for less

than 2 years, a reduced exclusion can be claimed. If this situation applies to a taxpayer, get Publication 523, which has a

worksheet that allows a homeowner to figure how to claim the

reduced exclusion.

 SUMMING UP THIS LESSON 

In this lesson you have learned the general rules that apply to

homeowners that sell or exchange their main home in 2002.

There are no special provisions for members of the Armed

Forces. For more information, see Publication 523.
OBJECTIVES

At the end of this lesson you will be able to:

1. Identify qualifying moves.

2. Determine when allowances and reimbursements must be

included in income.

3. Identify deductible moving expenses.

4. Compute the moving expense deduction using Form 3903,

Moving Expenses, for moves within or outside the 

United States.

INTRODUCTION

This lesson covers the moving expenses of military personnel.

When a member of the Armed Forces is transferred to a 

new permanent duty station, he or she may deduct certain

moving expenses.

Military personnel who have moved will need to determine

whether:

1. The move qualifies as a permanent change of station (PCS).

2. Moving expenses exceed allowances or reimbursements.

3. Allowances or reimbursements exceed moving expenses.

PERMANENT CHANGE OF STATION

For military moves, only expenses incurred as a result of a permanent change of station are deductible. A permanent change

of station includes:

■ A move from home to the area of the first post of active duty.

■ A move from one permanent post of duty to another.

■ A move from the last post of duty to home or to a nearer

point in the United States. The member must move within

one year of ending active duty or within the period allowed

under the Joint Travel Regulations.

Spouse and dependents. If a member of the Armed Forces

deserts, is imprisoned, or dies, a permanent change of station

for the spouse or dependents includes a move to the place of

enlistment, the home of record, or any nearer point in the

United States.

Lesson 12 12-1

MOVING EXPENSES

LESSON 12
12-2 Lesson 12

If the Armed Forces moves a member and his or her spouse or

dependents to or from separate locations, the moves are treated

as a single move to the member’s post of duty. The qualified

expenses of both moves are combined and deducted on the

same tax return.

Exercise 1

Which of the following is a permanent change of station?

A. A move by an Air Force pilot to an airbase for a 6-month

detail.

B. A move by an Army sergeant to his home 2 years after he

ended active duty.

C. A move by a new enlistee from her home to her first post

of duty.

Answer__________________________________________

REQUIREMENTS

The moving expense deduction includes only expenses that are

reasonable for the circumstances of the move. For example, the

costs of any side trips for sightseeing are not deductible. The

cost of lavish and extravagant lodging also is not deductible.

Although civilians must meet a distance test and a time test to

deduct moving expenses, members of the military can disregard

such tests for moves required by a permanent change of station.

PAYMENTS IN KIND, ALLOWANCES, AND

REIMBURSEMENTS

The service member must include in gross income any payments he or she receives from the government for a do-it-yourself (DITY) permanent change of station (PCS) move. A DITY

move payment is based on government estimates of the cost to

move household goods, not on actual expenses and receipts.

The service member will receive a separate Form W-2 for the

DITY payment. The amount in box 1 of the Form W-2 must be

included on line 7 of Form 1040. He or she must also complete

Form 3903 to compute total qualified moving expenses that can

be deducted on line 28, Form 1040. These line 7 and line 28

entries on Form 1040 will report the income and applicable

related expenses for the move on the Form 1040.

The service member does not include any of the following in his

or her gross income.

• Moving or storage services furnished to the member
• Non-taxable allowances such as:

• Dislocation allowance

• Temporary Lodging Allowance

• Mileage Allowance in Lieu of Transportation

• Per Diem Allowance

Generally, if total reimbursements or allowances received by

the service member are more than his or her qualified moving

expenses, the excess will be included with his or her wages in

box 1 of Form W-2. However, if reimbursements or allowances

(other than nontaxable allowances like the ones listed above)

exceed the cost of moving and they are not included in the

Form W-2, the service member must still include the excess on

line 7 of Form 1040.

Use Form 3903 to deduct qualified expenses that exceed reimbursements and allowances (including nontaxable allowances

like the ones listed above).

Exercise 2

A. A member of the Armed Forces must include in gross

income all reimbursements, allowances, and the value of

moving and storage services that the military organization

furnishes. True or false?

Answer__________________________________________

B. If a member of the Armed Forces receives reimbursements

or allowances (that are not excludable from gross income)

in excess of the actual moving expenses, he or she must

include in income only the amount that exceeds actual

expenses. True or false?

Answer__________________________________________

DEDUCTIBLE MOVING EXPENSES

Any qualifying moving expenses that exceed allowances or

reimbursements from the government are deductible. 

Members of the military will need to determine whether they

have excess expenses and, if so, whether the expenses are

deductible on their federal tax return.

Qualifying moving expenses are:

■ The cost of moving household goods and personal

effects, including hauling a trailer and packing, storage, and

insurance. It does not include the expense of moving furniture or other goods that the taxpayer bought on the way from

the old home to the new home. 

Lesson 12 12-3
12-4 Lesson 12

■ The cost of reasonable travel and lodging expenses

from the old home to the new home, including actual automobile expenses (or 13 cents per mile), airfare, and lodging for

the taxpayer and members of his or her household. Members

cannot deduct the cost of meals while traveling from the old

home to the new home.

Foreign moves. A foreign move is one from the United States

or its possessions to a foreign country or from one foreign country to another. It is not a move from a foreign country to the

United States or its possessions. 

Exercise 3

Which of the following are deductible moving expenses for

Major Boone? (Assume the member received no reimbursements from the government.)

A. Payment to Fulton Construction Company for home

improvements made to Major Boone’s former home.

B. Security deposit to Towner Apartments on the Boones new

apartment.

C. Commission to Mercer Real Estate for the sale of the

Boones’ former home.

D. Payment to Shelby Transport Company to ship a piano

that the Boones bought on the way to their new home.

E. Cost of transporting Major Boone’s second car to the new

job location.

F. Payment for meals while on the way to the new permanent

duty station.

Answer __________________________________________

REPORTING MOVING EXPENSES

Moving expenses are deductible as an adjustment to income

on Form 1040, line 28. Only deductible expenses that are more

than reimbursements and allowances can be claimed.

If the service member was not reimbursed, he or she can

deduct allowable moving expenses either in the year incurred

and paid or in the year they were paid.

If the member was reimbursed for expenses, he or she can

deduct allowable expenses either in the year incurred or in the

year paid.
Form 3903

Draft as of

6/14/2002

Moving Expenses OMB No. 1545-0062 Form 3903

 Attach to Form 1040.

Department of the Treasury

Internal Revenue Service

Attachment

Sequence No. 62

Name(s) shown on Form 1040 Your social security number

1

1

Enter the amount you paid for travel and lodging expenses in moving from your old home to

your new home. Do not include the cost of meals (see instructions)

2

3 Add lines 1 and 2

Enter the total amount your employer paid you for the expenses listed on lines 1 and 2 that is

not included in the wages box (box 1) of your W-2 form. This amount should be identified with

code P in box 12 of your W-2 form

4

Subtract line 4 from line 3. Enter the result here and on the “Moving expenses” line of

Form 1040. This is your moving expense deduction

5

Enter the amount you paid for transportation and storage of household goods and personal

effects (see instructions)

Before you begin:

2

3

5

4

Is line 3 more than line 4?

No. You cannot deduct your moving expenses. If line 3 is less than line 4, subtract line 3

from line 4 and include the result on the “Wages, salaries, tips, etc.” line of Form 1040.

(Rev. October 2002)

Yes.

 If you are a member of the armed forces, see the instructions to find out how to complete this form.

 See the Distance Test and Time Test in the instructions to find out if you can deduct your moving

expenses.

Shirley M. Harding 000 00 9876

500 00

500 00

350 00

150 00

If the member uses the cash method of accounting, which is

used by most individuals, he or she can choose to deduct moving expenses in the year of reimbursement if:

(l) The expenses were paid in a year before the year of reimbursement, or

(2) The expenses were paid in the year immediately after the year of reimbursement but by the due date, including

extensions, for filing his or her return for the

reimbursement year.

Moving expenses are reported on Form 3903, Moving Expenses.

For more information, see Publication 521, Moving Expenses.

The following example illustrates applications of the rules 

discussed in this lesson.

Example

Capt. Shirley M. Harding (SSN 000-00-9876) transferred in

2002 from one base to another. The government reimbursed her

$350 for her travel and lodging expenses on the way to her new

job location. The travel and lodging reimbursements were not

reported as income on Form W-2. The $5,000 expense for transporting her household goods was furnished in kind by the military. No other reimbursements or allowances were made.

Capt. Harding incurred the following expenses:

Travel and lodging en route –$500

The moving expense is computed on Form 3903 as follows:

Lesson 12 12-5

x
12-6 Lesson 12

Note: The $5,000 expense for transporting her household goods

was not included because the Armed Forces paid for this service.

The travel and lodging expenses for moving from the old home

to the new home are shown on line 2 of Form 3903.

Reimbursements are shown on line 4.

To figure the moving expense deduction on Form 3903, subtract

the total reimbursements on line 4 from the amount on line 3.

Check the “Yes” box and enter the result on line 5 and on Form

1040, line 28.

Exercise 4

Greg T. (SSN 000-00-4567) and Diane E. Carr are filing a joint

return. Greg T. Carr, an airman in the Air Force, was transferred from Maxwell Air Force Base to Scott Air Force Base.

The government reimbursed Greg $400 for travel expenses

incurred on the way to his new job location. He also received 

a $1,000 dislocation allowance. The travel and lodging reimbursements and the dislocation allowance were not reported

as wages on Form W-2. Using the following information 

furnished by the Carrs, complete Form 3903. 

Dislocation expenses: $1,000

Travel and lodging en route: $ 575

Meals en route: $ 200

Security deposit for new apartment: $ 350

Form 3903

Draft as of

6/14/2002

Moving Expenses OMB No. 1545-0062 Form 3903

 Attach to Form 1040.

Department of the Treasury

Internal Revenue Service

Attachment

Sequence No. 62

Name(s) shown on Form 1040 Your social security number

1

1

Enter the amount you paid for travel and lodging expenses in moving from your old home to

your new home. Do not include the cost of meals (see instructions)

2

3 Add lines 1 and 2

Enter the total amount your employer paid you for the expenses listed on lines 1 and 2 that is

not included in the wages box (box 1) of your W-2 form. This amount should be identified with

code P in box 12 of your W-2 form

4

Subtract line 4 from line 3. Enter the result here and on the “Moving expenses” line of

Form 1040. This is your moving expense deduction

5

Enter the amount you paid for transportation and storage of household goods and personal

effects (see instructions)

Before you begin:

2

3

5

4

Is line 3 more than line 4?

No. You cannot deduct your moving expenses. If line 3 is less than line 4, subtract line 3

from line 4 and include the result on the “Wages, salaries, tips, etc.” line of Form 1040.

(Rev. October 2002)

Yes.

 If you are a member of the armed forces, see the instructions to find out how to complete this form.

 See the Distance Test and Time Test in the instructions to find out if you can deduct your moving

expenses.
1. c.

2. a. False

b. True

3. e.

4. See completed Form 3903. The Carrs are entitled to a $175

moving expense deduction. Only the travel and lodging en

route can be claimed on Form 3903, line 2. The security

deposit and the meals are not deductible expenses. In addition, the dislocation allowance is netted against dislocation

expenses. Only if the dislocation expenses exceeded the dislocation allowance would the Carrs have reported the difference as an additional moving expense on Form 3903.

 SUMMING UP THIS LESSON 

In this lesson you learned what moves qualify for tax benefits,

what expenses are deductible, and how to use Form 3903 to

compute the moving expense deduction. These expenses are

deductible as an adjustment to income on Form 1040, line 28.

Lesson 12 12-7

MOVING EXPENSES ANSWERS TO EXERCISES LESSON 12
12-8 Lesson 12

Form 3903

Draft as of

6/14/2002

Moving Expenses OMB No. 1545-0062 Form 3903

 Attach to Form 1040.

Department of the Treasury

Internal Revenue Service

Attachment

Sequence No. 62

Name(s) shown on Form 1040 Your social security number

1

1

Enter the amount you paid for travel and lodging expenses in moving from your old home to

your new home. Do not include the cost of meals (see instructions)

2

3 Add lines 1 and 2

Enter the total amount your employer paid you for the expenses listed on lines 1 and 2 that is

not included in the wages box (box 1) of your W-2 form. This amount should be identified with

code P in box 12 of your W-2 form

4

Subtract line 4 from line 3. Enter the result here and on the “Moving expenses” line of

Form 1040. This is your moving expense deduction

5

Enter the amount you paid for transportation and storage of household goods and personal

effects (see instructions)

Before you begin:

2

3

5

4

Is line 3 more than line 4?

No. You cannot deduct your moving expenses. If line 3 is less than line 4, subtract line 3

from line 4 and include the result on the “Wages, salaries, tips, etc.” line of Form 1040.

(Rev. October 2002)

Yes.

 If you are a member of the armed forces, see the instructions to find out how to complete this form.

 See the Distance Test and Time Test in the instructions to find out if you can deduct your moving

expenses.

Greg T. and Diane E. Carr 000 00 4567 

575 00

575 00

400 00

175 00

x
OBJECTIVE

At the end of this lesson you will be able to identify travel and

transportation expenses (including meals) deductible by Armed

Forces members.

INTRODUCTION

This lesson identifies and explains how to apply the rules concerning travel and transportation expenses for members of the

Armed Forces.

GENERAL INFORMATION

Fully reimbursed employee business expenses, such as travel

and transportation expenses, generally are not reported on

your tax return if an adequate accounting is made to the

employer and any excess reimbursement is returned to the

employer.

Armed Forces employees must substantiate their expenses to

the federal government and return any excess reimbursement.

The records must be adequate and complete. Adequate records

include documents such as receipts and checks, account books,

diaries, trip sheets, or similar items. To be considered adequate, the records should show the business purpose, time,

place, and amount of the expense. If automobile expenses are

involved, the records must include the total miles driven and

total business miles driven.

FORM 1040

Deductible employee business expenses are reported generally

on Form 2106, Employee Business Expenses, and can only be

taken as an itemized deduction on Schedule A, Form 1040.

Only expenses that exceed 2% of adjusted gross income (AGI)

can be deducted.

Lesson 13 13-1

TRAVEL EXPENSES

LESSON 13
13-2 Lesson 13

Excess reimbursements for employee business expenses that

are not returned to the employer must be included in income

on line 7 of Form 1040. These reimbursements do not include

any “qualified military benefit,” such as per diem, as defined

in Lesson 1.

FORM W-2

If the employee is reimbursed under a plan which requires the

employee to adequately account for all business connected

expenses and return any funds that are more than the substantiated expenses, the reimbursement should not be included as

income in Box 1 of Form W-2. Therefore, the employee cannot

deduct these expenses.

Temporary duty (TDY) and temporary additional duty (TAD)

allowances for travel and transportation are not reported as

income on Form W-2. If there are excess expenses on some trips

and the employee wants to claim them as employee business

expenses, the employee must report all TAD and TDY trip

expenses incurred during the year on Form 2106 and include

all TAD and TDY allowances received as reimbursements.

FORM 2106

To claim unreimbursed job related expenses, such as travel or

transportation expenses, Armed Forces personnel must complete Form 2106 and attach it to their Form 1040. Form 2106

will not have to be used if the Armed Forces member is claiming only unreimbursed employee business expenses for professional dues, subscriptions to professional journals, educational

expenses, and uniform expenses. These expenses are reported

on line 20 on Schedule A as miscellaneous itemized deductions

subject to the 2% AGI limit.

Example

Capt. Grand traveled from his duty station in California to

Washington, DC, for a conference. He was away for 5 days. The

Army advanced Capt. Grand $700 for the trip. Capt. Grand’s

actual expenses were $625. When he filed his travel voucher

with the Army, he returned the excess of $75. The captain does

not have to complete Form 2106.

Remember, if the Armed Forces member does not claim

reimbursement for expenses that he or she is entitled to,

no deduction for those expenses is allowed.
MEALS

The cost of meals can be an employee business expense. This

includes meals while on business travel away from home and

for business-related entertainment. The deduction for meals is

generally limited to 50% of the actual expenses.

The deduction is taken on Form 2106 where the 50% limit is

applied before the amount is carried to line 20 on Schedule A

where it is subject to the 2% AGI limit.

If the employee is fully reimbursed for the meals under an

accountable plan that excludes reimbursement from gross

income, there is no amount to deduct and, therefore, no amount

subject to the 50% limit. For information on using the standard

meal allowance instead of actual expenses, see Publication 463,

Travel, Entertainment, Gift, and Car Expenses.

TRAVEL EXPENSES

To be deductible, travel expenses must be ordinary and necessary expenses of traveling away from home temporarily for

your job and must be greater than the total of any advances,

allowances, and reimbursements you receive for such expenses.

“Ordinary” expenses are customary or usual in the employee’s

field, trade, business, or profession. “Necessary” expenses are

appropriate or helpful in the employee’s job or business. Such

expenses include airfares, the costs of operating and maintaining a car, and meals and lodging. For a more complete list, see

Publication 463.

Deductible travel expenses are reported on Form 2106 

(or Form 2106-EZ, if you qualify) and are deductible as a 

miscellaneous itemized deduction on Schedule A of Form 1040.

Away From Home

For costs other than local transportation to be deductible, the

traveler must be away from home. The term “away from home”

has a special meaning for tax purposes.

“Home,” for this purpose, generally is the taxpayer’s main place

of business or post of duty. This includes the entire city or general area where his or her business or work is located, regardless of where the taxpayer or his or her family lives. For the

military, “home” is the permanent duty station. A naval officer

assigned to permanent duty aboard a ship that has regular eating and living facilities has a tax home aboard ship for travel

expense purposes.

“Away from home” means away for a period substantially

longer than an ordinary day’s work, during which taxpayers

need time off for sleep or rest to meet the demands of work. 

Lesson 13 13-3
13-4 Lesson 13

(For examples, see Traveling away from home in Publication

463.) Members of the Armed Forces are away from home if they

are away from their permanent duty stations long enough to

require significant rest or sleep in order to be able to conduct

and complete their duties.

Note: Away from home assignments that last, or are realistically expected to last more than one year are not temporary in

nature. Therefore, taxpayers cannot deduct travel expenses

incurred while on an assignment of more than one year. See

Publication 463, for more details.

No Deduction for Personal Expenses

For travel expenses to be deductible, there must be a workrelated purpose for the travel. The taxpayer may not deduct

expenses for personal travel, such as vacations, sightseeing,

entertaining, or family visits.

Allowable Expenses

Common travel expenses for a member of the Armed Forces

include:

■ Expenses incurred while on TDY or TAD if away from home

(ship, base, or station).

■ Expenses of a reservist attending drills away from home

overnight.

■ Meals and lodging of a reservist temporarily called to

active duty.

■ Travel expenses, including meals and lodging, incurred in

connection with deductible educational activities.

■ Travel expenses incurred when carrying on official business

while on “No Cost” (to the government) orders.

Mess bills afloat are not deductible by an officer assigned to

permanent duty aboard a ship. Bills may be deductible as

travel expenses by individuals and members of mobile units in

a travel or TAD status while away from their permanent ships

or stations.

Travel expense deductions are available to air squadron personnel when away from the squadron’s home base on TAD and to

Army personnel when on field duty or maneuvers in a TDY status. Air squadron personnel and members of staffs permanently

embarked on ships on extended deployments may not deduct

expenses of living aboard ships as travel expenses.

Officers assigned permanent duty afloat may deduct the cost of

meals and lodging incurred while on travel or TAD ashore if

the ship is not berthed at the temporary duty station, or if the

ship is berthed at the temporary duty station but quarters

LESSON 1
aboard are not available. No deduction is permitted for meals

or lodging furnished or available in kind at the place of TAD,

even if they are not used.

RESERVISTS

Unreimbursed travel expenses, including meals and lodging,

are deductible for military reservists who, under competent

orders and with or without compensation, must remain away

from their main place of business to perform authorized drills

and training duty.

Temporary active duty. Reservists temporarily called to

active duty may deduct meals and lodging while on active duty

if they kept their regular job while on active duty, returned to it

after release, and were stationed away from the general area of

that job or business. These expenses are deductible only if the

reservists pay for meals and lodging at their official military

post and only to the extent the expenses exceed BAH and BAS.

Exercise 1

A. Sgt. Meeker’s permanent duty station is in Korea. His wife

and children could not accompany him and have remained

at their home in the United States. Can he deduct the cost

of his meals and lodging?

Answer ____________________________________________

B. Can Sgt. Meeker, in the circumstances above, deduct the

cost of meals and lodging for his wife and children?

Answer ____________________________________________

C. Can Sgt. Meeker take a deduction for the cost of returning

home to visit his family?

Answer ____________________________________________

EDUCATIONAL EXPENSES

In Lesson 16, you will learn about deductions for educational

expenses. Taxpayers cannot deduct as a business expense the

cost of travel that in itself constitutes a form of education. If

educational expenses qualify for a deduction under the rules

Lesson 13 13-5
13-6 Lesson 13

given in Lesson 16, travel for that education is travel for a business purpose, and the unreimbursed transportation and meals

and lodging expenses may be deducted according to the relevant

rules discussed in this lesson.

Example

Airman Dawes is sent from his permanent duty station to a

technical school 500 miles away to learn the latest uses of computers for diagnosing engine performance and maintenance

requirements. If his expenses for travel exceed the allowances

and reimbursements he receives, he can take the excess as a

miscellaneous itemized deduction, subject to the 2% AGI limit.

Lesson 14 will explain which other educational expenses can be

deducted.

Exercise 2

Which of the following can be taken as deductions?

A. Travel expenses in excess of allowances and reimbursements when the taxpayer is on TAD trips.

B. Mess bills of an officer permanently assigned to a ship.

C. Meals that are not lavish or extravagant, but cost more

than allowances or reimbursements while the taxpayer

attends assigned schooling away from his or her permanent

station.

D. Laundry expenses the taxpayer incurs while traveling

on TAD and for which no allowance or reimbursement

is received.

Answer _____________________________________________

LOCAL TRANSPORTATION EXPENSES

Local transportation expenses are generally the expenses of

getting from one work place to another while not traveling

away from home. Such expenses include the costs of operating

and maintaining a car, but not meals and lodging. If taxpayers

are required during their time on duty to go from one place to

another (for example, as a courier or to attend meetings) without being away from home, their unreimbursed transportation

expenses are deductible. When they must use their own vehicle, they can deduct transportation expenses. You may be able

to use the standard mileage rate to figure the deductible costs

of operating your car for business purposes. Beginning January 1,
Lesson 13 13-7

2002, the standard mileage rate is 36.5 cents a mile for all

business miles driven on or after that date. This rate is adjusted

periodically for inflation. Commuting expenses are usually not

deductible. However, you may be able to deduct certain daily

transportation expenses, as explained next, under Temporary

Work Location.

TEMPORARY WORK LOCATION

A taxpayer can deduct local transportation expenses.

Local transportation expenses include the ordinary and necessary costs of all of the following.

■ Getting from one workplace to another in the course of the

taxpayer’s business or profession when he or she is traveling

within the city or general area that is his or her tax home.

■ Visiting clients or customers.

■ Going to a business meeting away from the taxpayer’s 

regular workplace.

■ Getting from the taxpayer’s home to a temporary workplace

when he or she has one or more regular places of work.

These temporary workplaces can be either within the area

of his or her tax home or outside that area.

Local business transportation does not include expenses the

taxpayer has while traveling away from home overnight. Those

expenses are deductible as travel expenses.

If the taxpayer’s employment at a work location is realistically

expected to last (and does in fact last) for one year or less, the

employment is temporary unless there are facts and circumstances that would indicate otherwise. If the taxpayer’s employment at a work location is realistically expected to last for more

than one year or if there is no realistic expectation that the

employment will last for one year or less, the employment is

not temporary, regardless of whether it actually lasts for more

than one year. If employment at a work location initially is

realistically expected to last for one year or less, but at some

later date the employment is expected to last for more than one

year, that employment will be treated as temporary (unless

there are facts and circumstances that would indicate otherwise) until the taxpayer’s expectation changes. It will not be

treated as temporary after the date the taxpayer determines it

will last for more than one year.
13-8 Lesson 13

 SUMMING UP THIS LESSON 

In this lesson you have learned that: 

 Travel and transportation expenses can be taken as miscellaneous itemized deductions on Schedule A, subject to the

2% AGI limit.

 Travel expenses for meals, lodging, and incidentals must

be incurred while temporarily away from home on business

to be deductible. Assignments that last, or are realistically

expected to last more than one year are not considered

temporary.

 Commuting and other personal expenses are not

deductible.

 Travel costs associated with deductible educational

expenses are treated like other business travel costs.

 Form 2106 and Schedule A (Form 1040) are used to figure

and claim the itemized deduction for employee business

expenses that exceed reimbursement.
1. a. No.

b. No.

c. No.

2. a., c., and d. 

Lesson 13 13-9

TRAVEL EXPENSES ANSWERS TO EXERCISES

LESSON 13
13-10 Lesson 13

STUDENT NOTES
OBJECTIVE

At the end of this lesson you will be able to identify miscellaneous itemized deductions of particular interest to the military.

INTRODUCTION

Certain miscellaneous itemized deductions, including unreimbursed employee business expenses and investment expenses,

are deductible only if the total deductions are more than 2%

of the taxpayer’s adjusted gross income (AGI). All deductible

miscellaneous itemized deductions discussed in this lesson are

subject to the 2% AGI limit. A general discussion of miscellaneous deductions appears in the Volunteer Assistor’s Guide.

This lesson explains some additional itemized deductions of

special interest to members of the military. To claim miscellaneous deductions, a taxpayer must use Schedule A (Form 1040),

Itemized Deductions.

UNIFORMS

Taxpayers can deduct the cost of buying and maintaining uniforms if the uniforms are specifically required as a condition 

of employment and they are not adaptable to general use as

regular clothing.

Generally, members of the Armed Forces are required to wear

uniforms when they are on duty but may be allowed to wear

them when they are off duty. Because their uniforms can be

worn in place of regular civilian clothing, members of the military cannot claim a deduction for uniform cost and upkeep.

However, if military regulations prohibit off-duty wear of certain uniforms, the member can deduct the cost and upkeep of

these uniforms. But he or she must reduce any deductible uniform costs incurred by any nontaxable uniform allowances or

reimbursements received to pay for these expenses.

Lesson 14 14-1

MISCELLANEOUS ITEMIZED

DEDUCTIONS

LESSON 14
14-2 Lesson 14

Active Duty Uniforms

Members of the Armed Forces on active duty can deduct

amounts spent to buy and maintain required military battle

dress uniforms and utility uniforms if local military regulations

prohibit their off-duty wear. The member must reduce the

expense by any nontaxable uniform allowance or reimbursement received.

Reservists’ Uniforms

A reservist in the Armed Forces can deduct the cost and upkeep

of uniforms if military regulations prohibit their wearing the

uniform except when performing duties as a reservist. The

reservist must, however, reduce the uniform expense by any

nontaxable uniform allowance or reimbursement received.

Articles Not Replacing Regular Clothing

A member of the Armed Forces can deduct the cost of required

items that do not replace regular clothing. Such items include

insignia of rank, corps devices, epaulets, aiguillettes, and swords.

Exercise 1

Indicate if the following are deductible or nondeductible by a

member of the Armed Forces.

A. The cost of an Army dress blue uniform (without shoulder

boards or gold stripe on pants), including cape. Off-duty

wear is not prohibited.

Answer__________________________________________

B. The cost of a full Army green uniform (without braid) that

can be worn anytime.

Answer__________________________________________

C. The cost of gold braid for decoration of a cap and uniform.

Answer__________________________________________

D. The cost of battle dress uniforms and utility uniforms that

can be worn only while on duty or while traveling to and

from duty.

Answer__________________________________________
PROFESSIONAL DUES

Taxpayers, including members of the Armed Forces, can deduct

dues paid to professional societies that are directly related to

their trade or business. For example, Lt. Margaret Allen, an electrical engineer at Maxwell Air Force Base, can deduct professional dues paid to the American Society of Electrical Engineers.

However, members of the Armed Forces cannot deduct amounts

paid to an officers’ club or a noncommissioned officers’ club.

EDUCATIONAL EXPENSES

Travel and transportation expenses for educational purposes

were discussed in Lesson 13. In this lesson, you will learn what

educational expenses can be claimed as miscellaneous deductions on Schedule A. Certain rules must be met, however, for

the expenses to qualify as a deduction.

Qualifications

A member of the Armed Forces can deduct expenses for

education, even though the education may lead to a degree, if

the education:

■ Is required by the taxpayer’s employer or by law or regulations

for the taxpayer to keep salary, status, or job (if these requirements serve a business purpose of his or her employer); or

■ Maintains or improves the skills required in the taxpayer’s

present work.

A taxpayer cannot deduct educational expenses, even though

the above requirements are met, if the education:

■ Is to meet the minimum educational requirements needed to

qualify the taxpayer in his or her trade or business, or

■ Is part of a program of study that will qualify the taxpayer

for a new trade or business, even if he or she has no plans to

enter that trade or business.

Some examples will help illustrate the various rules.

Example 1

Warrant Officer Nolan, an Army pilot, incurred educational

expenses to obtain an accounting degree. He cannot deduct these

expenses because they qualify him for a new trade or business.

Lesson 14 14-3
14-4 Lesson 14

Example 2

Lieutenant Commander Mason, who has a degree in financial

management, is in charge of base finance at her post of duty.

She incurred educational expenses when taking an advanced

finance course. She can deduct educational expenses that were

more than the educational allowance she received because she

had already met the minimum qualifications of her job. By taking the course, she improved skills in her current position. The

course did not qualify her for a new trade or business.

Deductible Expenses

Educational expenses and certain travel and transportation

expenses related to education may be claimed on Form 2106,

Employee Business Expenses. Expenses in excess of reimbursement are deductible only as a miscellaneous itemized deduction

on Schedule A, subject to the 2% AGI limit discussed earlier.

For more information, see Publication 508, Tax Benefits for

Work-Related Education, and Lesson 13, Travel Expenses, in

this publication.

Deductible educational expenses include amounts spent for

tuition, books, supplies, laboratory fees, correspondence

courses, costs of research, and typing as part of an educational

program, and travel. Educational expenses of a personal nature

are not deductible. For example, a taxpayer cannot deduct the

cost of dinner on campus while he or she attends evening

classes. Also, deductible educational expenses do not include

items of a capital nature, such as computers or desks.

Treatment of Allowances and Reimbursements

A member of the Armed Forces must reduce deductible educational expenses by any allowance or reimbursement he or she

receives. Any educational services provided in kind are not

deductible. For example, base-provided transportation to or

from class cannot be claimed.

Exercise 2

Sgt. Stephen Baker is a mess sergeant. On his own, he takes

courses at the local university in early childhood education.

Does he have deductible educational expenses? Why?

Answer ______________________________________________
Exercise 3

Specialist Bates is a qualified X-ray technician. Would he have

deductible educational expenses if he took a course required by

the Army in new radiology techniques? Assume his expenses

exceed reimbursement or allowance received.

Answer ____________________________________________

Exercise 4

Which of the following can be claimed as miscellaneous itemized deductions by a member of the Armed Forces?

a. Payment to an officers’ club.

b. Expenses incurred by a flight operations officer to obtain

an accounting degree.

c. Cost of epaulets.

d. Cost and upkeep of a reservist’s uniform when local 

military regulations prohibit off-duty wear. (No uniform

allowance received.)

e. Expenses incurred by a Navy disbursing clerk to learn 

television repair.

Answer __________________________________________

 SUMMING UP THIS LESSON 

In this lesson, you learned about some of the more common

itemized deductions of special interest to military members.

The total of these miscellaneous deductions must be more

than 2% of adjusted gross income to be deductible.

Lesson 14 14-5
14-6 Lesson 14

1. a. Nondeductible

b. Nondeductible

c. Deductible

d. Deductible

2. No. The courses were not required, do not improve 

Sgt. Baker’s skills as a mess sergeant, and could lead to

qualifying him for a new trade or business.

3. Yes. The course is required by Specialist Bates’ employer,

improves his skills in his present job, is not needed to meet

the minimum educational requirements for his job, and will

not lead to qualifying him for a new trade or business.

4. c. and d.

MISCELLANEOUS

ITEMIZED DEDUCTIONS ANSWERS TO EXERCISES

LESSON 14
OBJECTIVES

At the end of this lesson you will be able to:

1. Determine where and when to file a federal tax return.

2. Identify situations in which extensions of time to file are

granted and determine the length of these extensions.

3. Identify the deadline extension for combat zone participants.

INTRODUCTION

General rules for filing returns may be found in the Volunteer

Assistor’s Guide. This lesson addresses special concerns of

members of the Armed Forces and includes information for

combat zone participants.

TAXPAYER IDENTIFICATION

A member of the Armed Forces should include his or her name,

social security number, and permanent home address on his or

her return. A member who is due a refund and does not want it

mailed to his or her permanent home address should enter a

current address on the return. If the postal service does not

deliver to the member’s street address and the member has a

post office box, he or she should enter the post office box number on the line for the present home address. A military person

living overseas should use an APO or FPO address.

CHANGE OF ADDRESS

If a taxpayer changed his or her mailing address during the

year, the taxpayer should notify the Internal Revenue Service

of the change on Form 8822, Change of Address. However, if

the taxpayer moves after filing a tax return, he or she should

fill out and mail Form 8822 to the Internal Revenue Service

Center where his or her returns were previously filed.

Addresses for the service centers are listed on the back of the

form.

Lesson 15 15-1

FILING RETURNS

LESSON 15
15-2 Lesson 15

WHERE TO FILE

Taxpayers should send their federal returns to the service center for the place where they reside. For example, Sgt. Kane,

who is stationed in Maine but whose permanent home address

is in California, should send her federal return to the service

center for Maine. The tax form instructions give the addresses

for the service centers, including the Philadelphia Service

Center for APO and FPO addresses.

Taxpayers who live outside the United States and have no legal

residence or principal place of business in the United States

should send their returns to the address listed in the forms

instructions. Those who live in Guam or the Virgin Islands

should also use the addresses in the instructions. 

WHEN TO FILE

Most individual tax returns cover a calendar year, January

through December. Taxpayers who live in the United States or

Puerto Rico and who use the calendar-year period should file

their individual tax returns by April 15 of the following year.

If April 15 falls on a Saturday, Sunday, or legal holiday, the

due date is the next business day. (For 2002 tax returns, the

due date is April 15, 2003.) 

If a taxpayer has a balance due, they can pay by check, money

order, direct debit (automatic withdrawal) or credit card. See

Form 1040, 1040A, or 1040EZ instructions for complete details.

Taxpayers who cannot pay the tax due with their tax return

should attach Form 9465, Installment Agreement Request. The

Internal Revenue Service will try to arrange an installment

payment agreement that reflects the taxpayer’s ability to pay

the tax owed. However, taxpayers should pay as much as possible with their return to reduce the amount of interest and

penalties that will be charged on the unpaid balance.

EXTENSIONS

Taxpayers can receive extensions of time to file their returns.

Different rules apply to taxpayers who live in the United States

and those who live outside the United States. Deadline extensions are also available to members of the Armed Forces who

served in a combat zone.

IRS will charge interest on taxes not paid by the due date, even

if an extension of time to file is granted, unless the combat zone

extension is applicable.
Within the United States

A taxpayer living in the United States can receive an automatic

4-month extension of time to file his or her federal tax return. To

get the automatic extension, the taxpayer must file Form 4868,

Application for Automatic Extension of Time To File U.S.

Individual Income Tax Return, by the due date for the tax return.

Also see Paying by credit card, later.

The taxpayer is not required to pay any of the tax due when

submitting the form. However, the taxpayer will owe interest

on any tax that is owed but not paid by the due date. Interest

will be charged from the due date to the date of payment. In

addition, the taxpayer may be charged a late-payment penalty

if the amount of tax paid before the due date (from withheld

taxes or estimated tax payments) is less than 90% of the actual

tax owed.

For more details on penalties, refer to filing information 

in Publication 17 and lesson 7 in the Volunteer Assistor’s

Guide.

If Form 4868 is filed late, the request for an extension will be

denied. The Internal Revenue Service will inform the taxpayer

if the request is denied.

Taxpayers cannot use the automatic extension if they:

■ Choose to have the IRS figure their tax, or

■ Are under a court order to file their returns by the regular

due date.

When the tax return is actually filed, any payment made with

the application should be entered on line 67, Form 1040; added

to the total on line 43, Form 1040A; or added to the total on

line 10, Form 1040EZ.

The taxpayer can request an extension beyond this 4-month

period by filing Form 2688, Application for Additional

Extension of Time To File U.S. Individual Income Tax Return,

or by letter. Except in undue hardship cases, this additional

extension will not be granted unless Form 4868 has been filed

first. Form 2688 or the taxpayer’s letter will not be considered

if filed after the extended due date. 

Outside the United States and Puerto Rico

U.S. citizens and resident aliens who are living outside the

United States and Puerto Rico on April 15 and whose main

place of business or assigned tour of duty is outside the United

States and Puerto Rico are allowed an automatic 2-month

extension of time until June 15, 2003, to file a 2002 return.

However, interest will be charged from the due date to the date

the tax is paid. 

Lesson 15 15-3
15-4 Lesson 15

Note: Traveling outside the United States and Puerto Rico on

the due date does not qualify the taxpayer for an automatic 

2-month extension.

Taxpayers using this automatic extension must attach a statement to their return stating that they were living outside the

United States and Puerto Rico on the due date and that their

main place of business or their assigned tour of duty is outside

the United States and Puerto Rico.

Joint returns. For married persons who file jointly, only one

spouse needs to meet the requirements to take advantage of

the automatic extension to June 15.

Separate returns. For married persons who file separately,

only the spouse who meets the requirements qualifies for the

automatic extension. If both spouses meet the requirements,

each may take advantage of the extension. 

As discussed earlier, taxpayers who live outside the United

States and Puerto Rico and whose main place of business 

or assigned tour of duty is outside the United States and

Puerto Rico can also request an additional extension by filing

Form 4868 by the automatic extension date of June 15 or by

paying the tax due by credit card by April 15, 2003. The due

date will then be extended to August 15. To obtain the additional extension, the taxpayer must file Form 4868 and write

“Taxpayer Abroad” in the top margin of the form. If more time

is needed, the taxpayer should file Form 2688.

Paying by credit card. Taxpayers generally can get an extension by phone if they pay part or all of their estimate of income

tax due by using a credit card (American Express® Card,

MasterCard®, or Discover® Card) or by authorizing a direct

debit (automatic withdrawal) from the taxpayer’s checking or

savings account. To pay by credit card, taxpayers may pay by

phone or Internet by the regular due date of their income tax

return, and follow the instructions. If they pay the tax by credit

card, they do not have to file Form 4868. For more information,

get Form 4868 instructions.
Combat Zone Participants

The deadline for filing tax returns, paying taxes, filing claims

for refund, and taking other actions with the IRS is automatically extended for members of the Armed Forces who served in

a combat zone, qualified hazardous duty area, or began performing qualifing service outside of a combat zone or qualified

hazardous duty area. The designation of the combat zone and

the combat pay exclusion are described in Lesson 1.

The deadline for taking actions with the IRS is extended for at

least 180 days after the later of:

1. The last day a member is in a combat zone, qualified hazardous duty area, or has qualifying service outside of the

combat zone/qualified hazardous duty area (or the last day

the area qualifies as a combat zone/qualified hazardous duty

area), or

2. The last day of any continuous qualified hospitalization

(defined in Lesson 2) for injury from service in the combat

zone, qualified hazardous duty area, or qualified service outside the combat zone/qualified hazardous duty area.

Time in a missing status (missing in action or prisoner of war)

counts as time in a combat zone.

In addition to the 180 days, the deadline is extended by the

number of days that were left for the member to take the action

with the IRS when he/she entered a combat zone, qualified hazardous duty area (or began performing qualifying service outside of the combat zone/qualified hazardous duty area). If the

member entered the combat zone/qualified hazardous duty area

(or began performing qualifying service outside of the combat

zone/qualified hazardous duty area) before the period of time to

take the action began, the deadline is extended by the entire

time he/she had to take the action. For example, the member

has 31/2 months (Jan. 1–Apr. 15, 2002) to file his/her 2001

tax return. 

Any days of the 31/2 month period that are left when he/she

entered a combat zone (or the entire 31/2 months if the member

entered the combat zone before January 1) are added to the 

180 days to find the last day allowed for filing the 2001 

tax return.

Example 1

Capt. Margaret Jones entered Saudi Arabia on December 1,

2000. She remained there through March 31, 2002, when she

departed for the United States. She was not injured and did not

return to the combat zone. The deadlines for filing Capt. Jones’

2000, 2001, and 2002 tax returns are figured as follows:

Lesson 15 15-5
15-6 Lesson 15

The 2000 tax return deadline is January 10, 2003. Capt. Jones

has 285 days (180 plus 105) after her last day in the combat

zone (March 31) to file her 2000 tax return. The 105 additional

days are the number of days in the 31/2-month filing period that

were left when she entered the combat zone (Jan. 1–Apr. 15).

There are 105 days in the 2002 filing period. 

The 2001 tax return deadline is January 10, 2003. Capt. Jones

has 285 days (180 plus 105) after her last day in the combat

zone to file her 2001 tax return. 

The 2002 tax return deadline is not extended. The 180-day

extension period after March 31, 2002, ends on September 27,

2002, which is before the start of the filing period for her 2002

return.

Example 2

Petty Officer Leonard Brown’s ship entered the Persian Gulf on

January 5, 2001. On February 15, 2001, Leonard was injured

and was flown to a U.S. hospital. He remained in the hospital

through April 21, 2002. The deadlines for filing Petty Officer

Brown’s 2000, 2001, and 2002 returns are figured as follows:

The 2000 tax return deadline is January 27, 2003. Petty

Officer Brown has 281 days (180 plus 101) after his last day in

the hospital (April 21, 2002) to file his 2000 return. The 101

additional days are the number of days in the 31/2-month filing

period that were left when he entered the combat zone (Jan. 5–

Apr. 15). 

The 2001 tax return deadline is January 31, 2003. Petty

Officer Brown has 285 days (180 plus 105) after April 21, 2002,

to file his 2001 tax return. 

The 2002 tax return deadline is April 15, 2003. The 180-day

period after April 21, 2002, ends October 18, 2002, which is

before the start of the filing period for his 2002 return. The due

date for his 2002 return is not extended. He has until April 15,

2003 to file his 2002 tax return.

A detailed explanation of the deadline extension provision for

filing returns and taking care of other tax matters is included

in Lesson 3, Tax Benefits for Combat Zone Participants.

Interest. The IRS will pay interest from the regular due date

of a return if the return is timely filed (including extensions).

Identification of combat zone returns. Taxpayers can choose

to file their returns before the end of an extension period. They

should file their returns in accordance with procedures provided

by the Armed Forces.
Third-Party Designee. If the taxpayer wants to allow a

friend, family member, or any other person he or she chooses

to discuss his or her 2002 tax return with the IRS, the taxpayer

should check the “Yes” box in the “Third party designee” area

of the return. Also, the taxpayer should enter the designee’s

name, phone number, and any five numbers the designee

chooses as his or her personal identification number (PIN).

If the taxpayer checks the “Yes” box, he or she, and his or her

spouse if filing a joint return, is authorizing the IRS to call the

designee to answer any questions that may arise during the

processing of the return. The taxpayer is also authorizing the

designee to:

■ Give the IRS any information that is missing from the

return,

■ Call the IRS for information about the processing of the

return or the status of the taxpayer’s refund or payment(s),

and

■ Respond to certain IRS notices that the taxpayer has shared

with the designee about math errors, offsets, and return

preparation. The notices will not be sent to the designee.

The taxpayer is not authorizing the designee to receive any

refund check, bind the taxpayer to anything (including any

additional tax liability), or otherwise represent the taxpayer

before the IRS. If the taxpayer wants to expand the designee’s

authorization, he or she should see Publication 947, Practice

Before the IRS and Power of Attorney.

The authorization cannot be revoked. However, the authorization will automatically end no later than the due date (without

regard to extensions) for filing the taxpayer’s 2003 tax return.

This is April 15, 2004, for most people.

Lesson 15 15-7
15-8 Lesson 15

Power of Attorney. Use Form 2848, Power of Attorney and

Declaration of Representative, to grant authority to an individual to represent you before the IRS and to receive tax information. If an individual is acting on behalf of a taxpayer serving

in the combat zone and does not have a power of attorney specifying that he/she can handle federal tax matters, the IRS will

accept a general power of attorney or other statement signed

by the person for whom the individual is acting. The general

power of attorney or statement must authorize the individual

to act on the other person’s behalf even though federal tax matters are not specified. A copy must be attached to the tax return.

Signature. If it is not possible for the spouse of someone serving

in the combat zone to obtain that person’s signature on a joint

return, power of attorney, or other signed authorization to act on

his or her behalf, the IRS will accept a written statement explaining that the husband or wife is serving in the combat zone. 

The statement must be signed by the spouse filing the tax

return and attached to the return.

Exercise 1

Pvt. Franklin, a U.S. citizen, is a calendar-year taxpayer.

What would be the due date for him to file a return if his

assigned tour of duty were in the following places?

A. Puerto Rico

Answer__________________________________________

B. Germany

Answer__________________________________________

C. United States

Answer__________________________________________
Exercise 2

Capt. Russell is stationed in England on April 15. He is

concerned about when he should file his federal tax return.

Answer the following questions for Capt. Russell. 

A. What extensions of time are available to him?

Answer__________________________________________

B. How can he get those extensions?

Answer__________________________________________

Exercise 3 

Capt. McNulty entered the Persian Gulf area combat zone

on October 9, 2000, and left the combat zone on May 10, 2002.

She was not injured and did not return to the combat zone.

A. When are her 2000 and 2001 returns due after applying

the deadline extension provision?

Answer__________________________________________

B. How can she get this additional extension?

Answer__________________________________________

 SUMMING UP THIS LESSON 

In this lesson you have learned where members of the Armed

Forces should file their returns. You learned when the returns

are due for taxpayers who live both inside and outside the

United States and Puerto Rico and how extensions of time to

file can affect the due date. You have also learned that members of the Armed Forces who served in a combat zone are

allowed additional time to file their returns.

Lesson 15 15-9
15-10 Lesson 15

1. a. April 15

b. June 15 if he attached a statement to his return indicating that he was on an assigned tour of duty in Germany

on the due date.

c. April 15

2. a. An automatic 2-month extension of time to June 15 and

an additional 2-month extension to August 15 (for a total

of 4 months).

b. Captain Russell can obtain the automatic 2-month extension by attaching a statement to his tax return indicating

that he was on an assigned tour of duty outside the

United States and Puerto Rico on April 15. If Captain

Russell needs an additional extension of time, he should

file Form 4868 by the automatic extension date of June 15

and write “Taxpayer Abroad” in the top margin of the

form. If he still needs additional time, he should request it

before the extended due date of August 15 by filing Form

2688, or by letter.

3. a. Capt. McNulty has 285 days (180 plus 105) after her last

day in the combat zone (May 10, 2002) to file her 2000

return. She has 285 days (180 plus 105) after her last day

in the combat zone to file her 2001 return. These additional

days are the number of days in the 31/2 month filing period

that were left when she entered the Persian Gulf. Her 2000

return and her 2001 return are both due February 19, 2003.

b. Capt. McNulty should follow procedures provided by the

Armed Forces when filing her returns.

LESSON 15 FILING RETURNS ANSWERS TO EXERCISES
Lesson 16 16-1

OBJECTIVES

After completing this lesson you will be able to:

• Determine which credit is applicable

• Compute each credit by completing the Form 8863

• Determine the amount of tuition and fees deduction

• Determine allowable education expense deduction

INTRODUCTION

In this lesson, you will learn about the following education

credits.

• Hope Credit, and the

• Lifetime Learning Credit

AND education associated adjustments to income:

• Student Loan Interest Deduction

• Tuition and Fees Deduction

• Deduction for Educator’s Expenses

EDUCATION CREDITS

The two education credits are the Hope and the Lifetime

Learning Credit. The credits have some of the same criteria,

but differ as to when each can be taken.

The Hope Credit can only be taken the first two years of postsecondary education, generally the freshman and sophomore

years of college. The Hope Credit is available:

• Only for two years per eligible student.

• The student qualifying for this credit must be enrolled in a

degree or other recognized educational credential, and

• The student is enrolled in that program for at least one 

academic period during the year, and

• The student has no felony drug convictions on the student's 

record

The Hope Credit can be up to $1,500 per eligible student.

EDUCATION BENEFITS LESSON 16
16-2 Lesson 16

The Lifetime Learning Credit is available for all years of postsecondary education.

The Lifetime Learning Credit is available:

• For an unlimited number of years.

• Even if the student is not pursuing a degree or other recognized educational credential

The Lifetime Learning Credit can be up to $1,000 per tax

return.

NOTE: While the Lifetime Learning Credit can be taken for

any postsecondary education, if the student qualifies for either

credit, it is more advantageous to advise the taking of the Hope

credit when it is available. You cannot claim the Hope credit

and the lifetime learning credit on the same student in the

same tax year.

WHAT QUALIFIES FOR THE CREDIT

The Hope and the Lifetime Learning Credits are based on qualified tuition and related expenses for the taxpayer, their spouse

or dependents they claim on their tax return. Generally the

credit is allowed for qualified tuition and related expenses paid

in 2002 for an academic period beginning in 2002 or for the

first three months of 2003.

Qualified tuition and related expenses. In general, qualified tuition and related expenses are tuition and fees required

for enrollment or attendance at an eligible institution.

Student activity fees and fees for course-related books, supplies, and equipment are included in qualified tuition and

related expenses only if the fees must be paid to the institution

as a condition of enrollment or attendance.

Academic period. An academic period includes a semester,

trimester, quarter, or other period of study (such as summer

school session) as reasonably determined by the educational

institution.

Prepaid expenses. If you paid qualified tuition and related

expenses in 2002 for and academic period that begins in the

first three months of 2003, you can use the prepaid amount in

figuring your 2002 credit. As an example, if the taxpayer paid

$1,500 in December 2002 for qualified tuition for the winter

2003 semester, which begins in January 2003, the taxpayer can

use the prepaid amount to figure their credit for 2002.

Payment with borrowed funds. You can claim an education

credit for qualified tuition and related expenses paid with the

proceeds of a loan. You use the expenses to figure the credit of
the year in which the expenses are paid, not the year in which

the loan is repaid. However, you can still claim an adjustment

to income for the interest you pay when you are repaying the

loan.

Expenses that do not qualify. Qualified tuition and related

expenses do not include the cost of :

• Insurance

• Medical expenses (including student health fees)

• Room and board

• Transportation or

• Similar personal, living, or family expenses.

This is true even if the fee must be paid to the institution as a

condition of enrollment or attendance.

Qualified tuition and related expenses generally do not include

expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any non credit

course. However, if the course of instruction or other education

is part of student's degree program or, in the case of the

Lifetime Learning Credit, is taken by the student to acquire or

improve job skills, these expenses can qualify.

No double benefit allowed. You cannot:

• Deduct higher education expenses on your income tax return

and also claim an education credit base on the same

expenses.

• Claim a Hope Credit and a Lifetime Learning Credit based 

on the same qualified education expense or student (in the

same tax year).

• Claim a credit based on expenses paid with tax-free scholarship, grant, or employment-provided education assistance.

Adjustments to Qualified Expenses. If you pay higher education expenses with certain tax-free funds, you cannot claim a

credit for those amounts. You must reduce the qualified

expenses by the amount of any tax-free education assistance

you receive. Tax-free education assistance could include:

• Scholarships

• Pell grants

• Employer-provided education assistance

• Veteran’s education assistance, and

• Any other nontaxable payments (other than gifts, bequests,

or inheritances) received for education expenses

Lesson 16 16-3
16-4 Lesson 16

Do not reduce the qualified expenses by amounts paid with the

student’s:

• Earnings

• Loans

• Gifts

• Inheritances, and

• Personal savings

Also, do not reduce the qualified expenses by any scholarship

reported as income on the student’s return or any scholarship

which, by its terms, cannot be applied to qualified tuition and

related expenses.

Example 1

PV2 Charlie Delta is single, his SSN is 000-00-0004. Charlie

entered college for the first time as a freshman in 2002. He

paid qualified tuition and fees to school, which totaled $2,100.

In 2002, he received tuition assistance of $750. Compute Hope

credit on the Form 8863.

LESSON 1

Draft as of

/05/2002

OMB No. 1545-1618 Education Credits

Form 8863

 See instructions. Department of the Treasury

Internal Revenue Service

Attachment

Sequence No. 50

Name(s) shown on return Your social security number

Hope Credit. Caution: The Hope credit may be claimed for no more than 2 tax years for the same student.

1

2

3

Part I

3

(a) Student’s name

(as shown on page 1

of your tax return)

Add the amounts in columns (d) and (f)

Tentative Hope credit. Add the amounts on line 2, columns (d) and (f). If you are claiming

the lifetime learning credit, go to Part II; otherwise, go to Part III 

(f) Enter one-half

of the amount in

column (e)

(e) Subtract

column (d) from

column (c)

(d) Enter the

smaller of the

amount in

column (c) or

$1,000

(c) Qualified

expenses

(but do not

enter more than

$2,000 for each

student). See

instructions

2

(Hope and Lifetime Learning Credits)

(b) Student’s

social security

number (as

shown on page 1

of your tax return)

 Attach to Form 1040 or Form 1040A.

2002

Last name

First name

Charlie Delta 000 00 0004

Charlie

Delta 000 00 0004 1350 00 1000 00 350 00 175 00

1175 00

1000 00 175 00
Example 2

CPT Echo Fox is filing a joint return, his SSN is 000-00-0005.

In 2002, he began work on his master’s degree program. He

paid the school $3,500 in qualified tuition and fees for his

courses. He received no tuition assistance. Compute his 

lifetime learning credit on the Form 8863.

Lesson 16 16-5

Draft as of

6/05/2002

OMB No. 1545-1618 Education Credits

Form 8863

 See instructions. Department of the Treasury

Internal Revenue Service

Attachment

Sequence No. 50

Name(s) shown on return Your social security number

Hope Credit. Caution: The Hope credit may be claimed for no more than 2 tax years for the same student.

1

2

3

Lifetime Learning Credit

Part I

Part II

3

(a) Student’s name

(as shown on page 1

of your tax return)

Add the amounts in columns (d) and (f)

Tentative Hope credit. Add the amounts on line 2, columns (d) and (f). If you are claiming

the lifetime learning credit, go to Part II; otherwise, go to Part III 

Add the amounts on line 4, column (c), and enter the total

Enter the smaller of line 5 or $5,000

4

(f) Enter one-half

of the amount in

column (e)

(e) Subtract

column (d) from

column (c)

(d) Enter the

smaller of the

amount in

column (c) or

$1,000

(c) Qualified

expenses

(but do not

enter more than

$2,000 for each

student). See

instructions

2

Caution: You

cannot take the

Hope credit and

the lifetime learning

credit for the same

student.

(a) Student’s name (as shown on page 1

of your tax return)

First name Last name

(c) Qualified

expenses. See

instructions

Tentative lifetime learning credit. Multiply line 6 by 20% (.20) and go to Part III 

5

6

7

5

6

7

(Hope and Lifetime Learning Credits)

(b) Student’s

social security

number (as

shown on page 1

of your tax return)

(b) Student’s social security

number (as shown on page

1 of your tax return)

 Attach to Form 1040 or Form 1040A.

2002

Last name

First name

Echo Fox 000 00 0005

Echo Fox 000 00 0005 3500

3500

3500

700
16-6 Lesson 16

Refunds of Education Expenses

Qualified tuition and related expenses do not include expenses

for which you receive a refund. If you paid expenses in 2002

and you received a refund before you file your tax return for

2002, simply reduce the amount of the expenses paid by the

amount of the refund received. If you receive the refund after

you file your 2002 tax return, you will need to file an amended

return (1040X) to recalculate the credit and repay the excess

credit claimed.

Student Loan Repayment Program

When some service members enlist, they get their student

loans repaid as an enlistment incentive. The amount of the

student loan repayment will show on their W-2 statement as

other wages (in Box 14) and this amount must be included with

amount in Box 1 income on their W-2 before entering on the

“Wages, salaries, tips, etc.) line of the appropriate tax return.

STUDENT LOAN INTEREST DEDUCTION

You may be able to deduct up to $2,500 of the interest you pay

in 2002 on a qualified student loan.

Note: Effective for 2002, student loan interest qualifies as an

adjustment, even if the required payment began more than 60

months ago.

You cannot claim the deduction if:

• Another taxpayer claims an exemption for you as a

dependent

• Your filing status is married filing separately, or

• You are not legally obligated to make payments on the loan.

A qualified student loan is a loan you took out to pay qualified

expenses. The expenses must have been:

• For you, your spouse, or a person who was your dependent

when you took out the loan.

• Paid or incurred within a reasonable time before or after you

took out the loan, and

• For education furnished during a period when the recipient

was an eligible student.

The student must have been enrolled in a degree, certificate, or

other program leading to a recognized educational credential at

an eligible institution and must have carried at least on half of

a normal full-time workload for the course of study being pursued.
The deduction is phased out ratably over a range that:

• Begins when modified AGI exceeds $50,000 ($100,000 if married filing jointly or qualified widow(er), and

• Ends at $65,000 ($130,000 if married filing jointly or qualifying widow(er)

If the student paid $600 or more of interest on a qualifying student loan during the year, the student should receive a Form

1098-E – Student Loan Interest Statement from the financial

institution, governmental unit (or any of its subsidiary agencies), educational institutions, or any person to whom you had

paid student loan interest of $600 or more in the course of their

trade or business. Interest on a loan from a related party,

including the taxpayer's spouse, brothers or sisters, halfbrother or sister, ancestors (parents, grandparents, etc.) and

lineal descendents (children, grandchildren) may not be

deducted.

TUITION AND FEES DEDUCTION

Taxpayers can claim an itemized deduction for education

expenses of Form 1040, Schedule A as a miscellaneous expense

limited to 2% of AGI.

Beginning in 2002, taxpayers can deduct an amount equal to

the qualified tuition and related expenses paid during the tax

year as an adjustment to income. The adjustment is reported

on Form 1040, line 26, or Form 1040A line 19.

To claim the deduction the taxpayer must have incurred qualified expenses for an eligible student to attend an eligible educational institution during the tax year.

For more information, refer to lesson 4 in Publication 678.

DEDUCTION FOR EDUCATOR EXPENSES

If the taxpayer or the spouse is an eligible educator, he or she

can deduct as an adjustment to income up to $250 in qualified

expenses. The taxpayer can deduct these expenses even if he

or she does not itemize deductions on Schedule A. This adjustment to income is for expenses paid or incurred in 2002.

Previously, these expenses (without the $250 limit) were

deductible only as a miscellaneous itemized deduction subject

to the 2% of AGI limitation.

Lesson 16 16-7

LESSON 1
16-8 Lesson 16

The taxpayer will be considered an eligible educator if he or she

is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide and he or she works at least 900 hours

during a school year at a school that provides elementary or

secondary education.

Qualified expenses are limited to the non-reimbursed expenses

paid or incurred for books, supplies, computer equipment or

other related supplementary materials that the taxpayer uses

in his or her classroom. For courses in health and physical

education, expenses for supplies are qualified expenses only if

they relate to athletics.

The educator expense can be claimed on Form 1040, line 23 or

Form 1040A, line 18.

 SUMMING UP THIS LESSON 

 There are two credits available for qualified educational

expenses. The Hope Credit and the Lifetime Learning

Credit are non-refundable, educational credits.

 You cannot claim the Hope Credit and the Lifetime Learning

Credit for the same student for the same year.

 The educational credits are calculated on Form 8863.

 A new adjustment to income is available for tuition and fees

paid by the taxpayer.

 A new adjustment to income is available for qualified educator's expenses.
OBJECTIVES

At the end of this lesson you will be able to:

1. Describe what an Individual Retirement Arrangements (IRA)

is.

2. List when contributions are tax deductible.

3. Explain the difference between a Traditional IRA and a Roth 

IRA.

4. List who qualifies to participate in the Thrift Savings Plan

(TSP) and the tax benefits for participation.

INTRODUCTION

This lesson describes Individual Retirement Arrangements

(IRA), the different types, when contributions to them can be

made, how much can be contributed to an IRA and the deadline

for making contributions for those serving in a combat zone.

This lesson also includes information on the Thrift Savings

Plan (TSP). It tells what it is, who is eligible to make contributions and the rules associated when a service member serves in

a combat zone.

INDIVIDUAL RETIREMENT ARRANGEMENTS (IRA)

An individual retirement arrangement, or IRA, is a personal

savings plan, which allows individuals to set aside money for

retirement, while offering tax advantages. Taxpayers may be

able to deduct some or all of their contributions to a traditional

IRA. Amounts in a traditional IRA, including earnings, generally are not taxed until distributed. IRA's cannot be owned

jointly. However, any amounts remaining in an IRA upon a

taxpayer's death can be paid to his or her beneficiary or beneficiaries.

The two types of IRA’s discussed in this lesson are:

1. Traditional IRA (those that are not Roth or SIMPLE IRA's)

2. Roth IRA, which features nondeductible contributions and 

tax free distributions.

Lesson 17 17-1

INDIVIDUAL RETIREMENT

ARRANGEMENTS (IRA) AND

THRIFT SAVINGS PLAN (TSP)

LESSON 17
17-2 Lesson 17

Contributions

To contribute to a Traditional IRA, individuals must be under

age 701/2 at the end of the tax year and they, or their spouse if

filing a joint return, must have taxable compensation, such as

wages, salaries, commissions, tips, bonuses, or net income from

self-employment. In addition, taxable alimony and separate

maintenance payments received by an individual are treated as

compensation for IRA purposes.

Compensation does not include earnings and profits from property, such as rental income, interest and dividend income or

any amount received as pension or annuity income, or as

deferred compensation.

Contributions to the Roth IRA are not deductible. The amount

that can be contributed is reduced by any amounts contributed

to a Traditional IRA. Contributions are first applied to a

Traditional IRA, then to a Roth IRA. Contributions to a Roth

IRA are permitted after 701/2.

For 2002, taxpayers may contribute up to $3,000 for the year to

a Traditional IRA or a Roth IRA. Contributions up to $3,000 in

total may be allocated between the two types of IRAs.

Under a special catch-up provision, individuals who are age 50

or older before the close of the taxable year may make additional contributions. The catch-up provision increases the maximum annual contribution amount for future taxable years by

$500.

Deductibility of Contributions to Traditional IRAs

The contributions made to a Traditional IRA may be deductible

for income tax purposes. As military members are deemed

"active participants" in a qualified retirement plan, the portion

of the contribution to a Traditional IRA they may deduct can

decline or be eliminated altogether. IMPORTANT — all nondeductible contributions to Traditional IRAs are not taxed

when the funds are withdrawn. They were already taxed

because they could not be deducted when made. If either the

Traditional IRA account holder or their spouse is an active participant in a qualified retirement plan, then the amount

deductible is reduced or eliminated once the adjusted gross

income exceeds a certain amount (see Publication 590 for more

information).
Premature Withdrawals — Traditional IRA’s

Taxpayers are subject to an additional ten-percent income tax,

which will be imposed on the taxable portion of a distribution

from an IRA if the early withdrawal is taken before the account

holder reaches age 591/2, unless an exception applies.

Conversions From Traditional IRAs

Traditional IRA can be converted or rolled into a Roth IRA as

long as the taxpayer is either a single filer or a married person

filing jointly whose modified adjusted gross income does not

exceed $100,000.

Traditional IRA to Roth IRA conversions are not allowed for

married persons filing separate returns. A married person filing separately, who has lived apart from his or her spouse for

the entire year is treated as single for this purpose.

The regulations specify three methods by which such a conversion can occur.

a. A distribution from a Traditional IRA that is rolled 

over to a Roth IRA within 60 days;

b. A financial institution to transfer from a Traditional 

IRA to a Roth IRA; or

c. A transfer from a Traditional IRA to a Roth maintained by the same trustee.

The taxable portion of the IRA will be subject to income tax,

but not to the ten percent additional income tax for premature

withdrawals or the six percent excess contribution excise tax.

The ten percent early withdrawal penalty tax applies to a

Traditional IRA rollover conversion that is distributed to the

account holder within the five-taxable-year period beginning in

the year in which it was made as if that amount is included in

gross income, unless an exception applies.

Military Taxpayers

The deadline for making a contribution to a Traditional IRA for

the year is the due date of you return, not including any extensions of time to file. Military members deployed to a certified

combat zone have additional time to make a qualified retirement contribution to an IRA until 180 days after the late of:

 The last day you are in a combat zone/qualified haz

ardous duty area or have qualifying service outside of

the combat zone/qualified hazardous duty area (or the

last day the area qualifies as a combat zone or qualified hazardous duty area), or 

Lesson 17 17-3
17-4 Lesson 17

 The last day of any continuous qualified hospitalization (defined later) for injury from service in the 

combat zone/qualified hazardous duty area or while 

performing qualifying service outside of the combat

zone/qualified hazardous duty area.

THRIFT SAVINGS PLAN (TSP)

The Thrift Savings Plan (TSP) is a retirement savings and

investment plan that has been available to civilian employees

of the Federal Government since 1987 and was made available

to members of the Armed Forces members in 2002. The purpose of the TSP is to provide retirement income. It offers participants the same type of savings and tax benefits that many

private corporations offer their employees. The TSP allows

participants to save a portion of their pay in a special retirement account administered by the Federal Retirement Thrift

Investment Board. The money that participants invest in the

TSP comes from pre-tax dollars and reduces their current taxable income; investments and earnings are not taxed until they

are withdrawn.

Participation.

The TSP differs from the Military Retirement System in that

participation in the TSP is optional and not automatic. Armed

Forces members must sign up with their service to participate

in the TSP. They contribute to the TSP from their own pay on

a pre-tax basis, and the amount they contribute and the earnings attributable to their contributions belong to the service

member. They are the service member's to keep even if they do

not serve the 20 years ordinarily necessary to receive military

retired pay.

Uniformed members of the Army, Navy, Air Force, Marine

Corps, Coast Guard, Public Health Service, and the National

Oceanic and Atmospheric Administration serving on active duty

and members of the Ready Reserve or National Guard of those

services (as applicable) in any pay status can contribute to the

TSP.

Contributions

In 2002, service members could contribute up to 7% of their

basic pay earned each month. Service members were also able

to contribute all or any whole percentage of any special or

incentive pay (including reenlistment or other bonuses) they

receive. However, the total amount they can contribute each

year cannot exceed the Internal Revenue Code's elective deferral limit of $11,000 for 2002.
A service members' payroll office will deduct contributions from

military pay each month based on the election and will remit

these contributions to the TSP. Service members cannot send a

check to the TSP; once the service member receives his pay, he

or she cannot contribute any of it to the TSP.

Combat Zone rules.

If the service member served in a combat zone, special rules

apply. Because all or part of pay earned during a month a combat zone is tax exempt, they do not receive the benefit of tax

deferral when they contribute it to the TSP. As a consequence,

contributions from tax-exempt pay are not subject to the elective deferral limit.

Tax Saver's Credit

Members, who participate in the TSP during tax years 2002

through 2006, may be eligible for a tax credit on their federal

income tax return for each year they contribute to the plan.

For married members who file a joint return, the maximum

credit is $2,000.

For single members, the maximum credit is $1,000. However,

the amount of the tax credit may be offset by any taxable distribution paid directly to them by the TSP. This benefit, called

the saver's tax credit, is available to participants with an

adjusted gross income of no more than $50,000 if married filing

jointly, $37,500 if head of household, or $25,000 if single or

married filing separately.

Lesson 17 17-5

 SUMMING UP THIS LESSON 

In this lesson you have learned that:

 Taxpayers can contribute up to $3,000 $6,000 if married, to a

Traditional IRA or Roth IRA in 2002. Only contributions to

a Traditional IRA are tax deductible.

 Military members deployed to a combat zone have 180 days

of additional time, to make qualified retirement contribution

to an IRA, after they leave the combat zone.

 The Thrift Savings Plan is a retirement savings and investment plan that is now available to members of the Armed

Forces. Service members could contribute up to 7 percent of

their basic pay earned each month in 2002. Service members were also able to contribute all or any whole percentage

of special, incentive, or bonus pay they received. The maximum amount they could contribute in 2002 was $11,000.
17-6 Lesson 17

STUDENT NOTES
Lesson 18 18-1

OBJECTIVES

At the end of this lesson, you will be able to:

1. Determine when business income must be reported using

the schedule C or C-EZ.

2. Determine when a Schedule SE must be filed.

3. Properly complete the Schedule E.

INTRODUCTION

In lesson 1 we discussed what the definition of Gross Income is.

Included in that definition was self employment income. In this

lesson we will discuss how to handle self-employment income

and what is required in order to prepare a tax return with a

schedule C or C-EZ. Many military members and their spouses

may earn additional income as sole proprietors and not be

aware of their responsibility to report it. In some cases, income

received is reported to those individuals by means of Form

1099-MISC. In other cases just cash or checks are received

through the mail or personally handed to the taxpayer.

DETERMINING WHICH TAX YEAR TO REPORT THE

BUSINESS INCOME

Under the cash method, a self-employed taxpayer includes in

his or her business gross income all items of income actually or

constructively received during the tax year. If a taxpayer

received property or services, he or she must include the fair

market value of those items received in income. 

Example

On December 30, 2001, a customer mailed a check for interior

decorating services provided by Kathy (your taxpayer). Kathy

received the check on January 2, 2002. Kathy must include the

amount of the check in income for 2002. 

Constructive receipt. You have constructive receipt of income

when an amount is credited to your account or made available

to you without restriction. You do not need to have possession

of it. If you authorize someone to be your agent and receive

income for you, you are treated as having received it when your

agent received it. 

OTHER INCOME LESSON 18
18-2 Lesson 18

Example

Interest is credited to your bank account in December 2002.

You do not withdraw it or enter it into your passbook until

2003. You must include it in your gross income for 2002.

Delaying receipt of income. You cannot hold checks or postpone taking possession of similar property from one tax year to

another to avoid paying tax on the income. You must report the

income in the year the property is received or made available to

you without restriction.

Example

Frances Jones, a service contractor, was entitled to receive a

$10,000 payment on a contract in December 2002. She was told

in December that her payment was available. At her request,

she was not paid until January 2003. She must include this

payment in her 2002 income because it was constructively

received in 2002.

Checks. Receipt of a valid check by the end of the tax year is

constructive receipt of income in that year, even if you cannot

cash or deposit the check until the following year.

Example

Mrs. Redd received a check for $500 on December 31, 2002,

from a parent in her day care business. She could not deposit

the check in her business account until January 2, 2003. She

must include this fee in her income for 2002.

INCOME

Business income may be reported to taxpayers in various ways

or even not at all. Some taxpayers receive informational

returns such as the 1099 MISC other times it may be just a

check or cash for services performed. Regardless of how income

is received, self-employed taxpayers are responsible for recording the amount of income received, and related expenses, in

their permanent books of record. Normally, the easiest record

keeping is maintaining a separate business checking account.

From these records the taxpayer should be able to state to you

the total gross receipts or sales for the year, any returns and

allowances (although normally a cash based taxpayer should

not have any of these since income is reported at the end of the

year) and the Cost of Goods Sold. We will discuss deductions

for expenses later in the lesson.
DEDUCTIONS FOR EXPENSES

In earlier chapters you learned about deductions from gross

income. The same concept applies to business gross income.

Self-employed taxpayers are allowed to deduct from income

those “ordinary and necessary” expenses paid or incurred during the taxable year in carrying out a trade or business. 

Auto Expenses

Business auto expenses can be calculated by either the actual

cost method or the standard mileage method. The taxpayer

usually makes the choice of which method to use the first year

that the vehicle is used for the business. It is permissible to

switch from the standard mileage method to the actual expense

method; however, taxpayers generally are not permitted to

switch from actual method to the standard mileage method.

The Standard Mileage Method is available for both owned

and leased autos. However, the vehicle must not be used for

hire (such as a taxi or shuttle van). The election to use the

standard mileage method must generally be made in the year

the auto is first used in business. In a later year the taxpayer

may switch to the actual expense method but cannot claim any

depreciation, if the vehicle is considered fully depreciated. In

leased cars the standard mileage method must be for the entire

lease period of the auto. 

In 2002 the standard mileage rate is 36.5¢. 

Expenses not included in the standard mileage allowance and

deductible in addition to the standard mileage allowance are

business parking fees and tolls, and interest on auto loan (business portion).

A taxpayer is limited to the actual expense method if any of the

following are true:

1. ACRS or MACRS Depreciation has previously been claimed

on the auto.

2. A section 179 expense has been claimed on the auto.

3. Any method of depreciation on the auto other than straight

line over the estimated useful life of the auto.

Under this method the taxpayer determines the actual cost of

those items listed under the standard mileage rate and deducts

that amount. Both methods should be considered to determine

which gives the most beneficial deduction to the taxpayer.

Lesson 18 18-3
18-4 Lesson 18

CRITERIA FOR FILING SCHEDULE C-EZ

AND SCHEDULE C

In order to file the EZ version of the Schedule C the taxpayer

must meet the criteria listed below:

1. Have less than $2,500 in business expenses

2. Use the Cash method of accounting

3. Have no inventory at any time during the year

4. Have positive net income (not have a net loss)

5. Operate only one business as a sole proprietor during the

tax year

6. Have no employees during the year.

Example

Jerry owns and operates a one-person tax preparation business during the filing season. His income is $1,500 accounted

for via the cash method; this is the only business he operated

during the year. He has the following expenses, paper $400,

and ink $200. Since Jerry’s expenses total $600 Jerry has met

all the requirements and therefore can use the Schedule CEZ

for reporting his business income.

Exercise 1

Jim is the civilian spouse of Lt. Carry Ann. He operates a business (sole proprietorship) as a lawyer. His gross income from

business is $70,000. His total business expenses amount to

$1,800. He can use the Schedule C-EZ yes or no?

Answer ____________________________________________

LESSON 1
Exercise 2

Martha is the wife of Stuart, a Marine stationed in California.

During the year Martha operates a sole proprietorship called

Squared Away Child Care services. She comes to you for help

with her return. A review of her records reflect the following:

Income: $6,700

Expenses:

Advertising $600

Car & Truck $150

Office Expense $500

Toys and Games $200

Telephone $800

Utilities $300

Total Expenses $2,550

Net Income $4,150

Should Martha file a Schedule C or Schedule C-EZ?

Answer ____________________________________________

SCHEDULE SE

If the net income on the Schedule C or Schedule C-EZ is $400

or more, you will need to file a Schedule SE. The Schedule SE

calculates the self-employment tax, which is comprised of the

Social Security and Medicare taxes.

SCHEDULE E

For the military, rental income and expenses is a frequent

occurrence since many military members are not able to sell

their homes when they get orders to relocate. Many homeowners rent out their old home. The income and the expenses from

the rental of the property are recorded on Schedule E. This

section will provide basic guidance on how to complete the

Schedule E.

We will not discuss the calculation of depreciation.

Depreciation is a complex subject. If the taxpayer provides you

with the depreciation amount, you can enter it on the tax

return. If the taxpayer does not know the depreciation amount,

you may need to refer them to a paid tax professional.

In the first year of the rental, you might have to divide the

mortgage interest and real estate taxes between Schedule A

and Schedule E. You simply divide the total mortgage interest

Lesson 18 18-5
18-6 Lesson 18

and property taxes by twelve and multiply by the number of

moths the home was used for each purpose.

Example

Sgt Jones lived in his home through September 2002. He got

orders and rented his home out in October. Nine months of the

mortgage interest and property taxes would go on his Schedule

A and the other three months would go on the Schedule E.

Remember, also, that three months of his property insurance is

also a deductible item on Schedule E, even though this expense

is not deductible when the home is his residence.

Other expenses that are deductible for rental property are:

cleaning and maintenance, repairs, utilities that are paid for

the tenant, legal and professional fees, management fees you

pay a real estate company or individual to care for your property in your absence, auto and travel expense to check on the

property, long distance phone calls, etc.

Once you deduct all of the expenses and the depreciation from

the rent received, you may come up with a loss. The net

income or loss from rental property is usually considered passive. If the taxpayer actively participates in the renting of the

property (such as making decisions, determining who can rent

the property), the loss is fully deductible.

 SUMMING UP THIS LESSON 

 Business income is reported on either a Schedule C or C-EZ.

 The Schedule C-EZ has limited use.

 Schedule SE is used to calculate the self-employment tax

when the net business income exceeds $400.

 Schedule E is used to report rent and royalty income.

ANSWERS TO EXERCISES

1. Yes

2. Schedule C
PROBLEM 1

Sgt. Michael A. Adams, SSN 271-00-3456, is stationed in

Heidelberg, Germany, on April 15, 2003. He and his wife,

Frieda F., a citizen of Germany, SSN 654-00-3217, want to

make the special choice to file a joint return. They have one

son, John, age 4, SSN 231-00-6457, who qualifies as their

dependent. Their address in Heidelberg is 3/45 Aviation Bn,

APO New York 09036.

Sgt. Adams had the following sources of income: wages of

$33,520; interest of $40; uniform allowance of $150; and basic

allowance for housing (BAH) of $7,480. Sgt. Adams had $2,500

of federal income tax withheld from his wages. His wife had

no income. Both spouses want to contribute $3 to the

Presidential Election Campaign Fund.

a. When should the Adamses file their return?

Answer_________________________________________________

b. Complete Form 1040A for Sgt. Adams and his wife.

SP-1 Summary

Problems

SUMMARY PROBLEMS
Draft as of

6/05/2002

Form Department of the Treasury—Internal Revenue Service

1040A 2002 U.S. Individual Income Tax Return

OMB No. 1545-0085

Your social security number

Your first name and initial Last name Label L

A

B

E

L

H

E

R

E

(See page 19.)

If a joint return, spouse’s first name and initial Last name Spouse’s social security number

Use the

IRS label. Home address (number and street). If you have a P.O. box, see page 20. Apt. no.

You must enter your

SSN(s) above.

City, town or post office, state, and ZIP code. If you have a foreign address, see page 20.

Filing

status

No. of boxes

checked on

6a and 6b

Yourself. If your parent (or someone else) can claim you as a

dependent on his or her tax return, do not check box 6a. Exemptions 6a

b Spouse No. of children

on 6c who: (4) if qualifying

child for child

tax credit (see

page 23)

(2) Dependent’s social

security number

c ● lived with

you

● did not live

with you due

to divorce or

separation

(see page 24)

If more than six

dependents,

see page 22.

Dependents

on 6c not

entered above

d

Add numbers

on lines Total number of exemptions claimed. above

7 Wages, salaries, tips, etc. Attach Form(s) W-2. 7

8a Taxable interest. Attach Schedule 1 if required. 8a

b Tax-exempt interest. Do not include on line 8a. 8b

Attach

Form(s) W-2

here. Also

attach

Form(s)

1099-R if tax

was withheld.

9 Ordinary dividends. Attach Schedule 1 if required. 9

IRA

distributions.

11a Taxable amount

(see page 25).

11b

Enclose, but do

not attach, any

payment.

11a 11b

Taxable amount

(see page 26).

12a Pensions and 12b

annuities. 12a 12b

13 Unemployment compensation and Alaska Permanent Fund dividends. 13

14a Taxable amount

(see page 28).

Social security

benefits.

14b

14a 14b

15 Add lines 7 through 14b (far right column). This is your total income.  15

17 IRA deduction (see page 28). 17

Student loan interest deduction (see page 31).

Income

18

Add lines 16 through 19. These are your total adjustments. 20

Subtract line 20 from line 15. This is your adjusted gross income. 

18

21

Dependents:



Check only

one box.

If you did not

get a W-2, see

page 25.

Form 1040A (2002)

IRS Use Only—Do not write or staple in this space.

(3) Dependent’s

relationship to

(1) First name Last name you

20

21

Adjusted

gross 

income

 Important! 

Cat. No. 11327A

Otherwise,

please print

or type.

For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see page 53.

(99)

10 Capital gain distributions (see page 25). 10

Presidential

Election Campaign

(See page 20.)  Yes No

Note. Checking “Yes” will not change your tax or reduce your refund.

Do you, or your spouse if filing a joint return, want $3 to go to this fund?  No Yes

You Spouse

19 Tuition and fees deduction (see page XX). 19

1 Single

2 Married filing jointly (even if only one had income)

3

Qualifying widow(er) with dependent child

(year spouse died  ). (See page 22.)

Married filing separately. Enter spouse’s SSN above and

full name here. 

Head of household (with qualifying person). (See page 21.)

If the qualifying person is a child but not your dependent,

enter this child’s name here. 

4

5

16 Educator expenses (see page XX). 16

SP-2 Summary

Problems

EXHIBIT P-1 Form 1040A-Pg. 1
SP-3 Summary

Problems

EXHIBIT P-2 Form 1040A-Pg. 2

Draft as of

6/05/2002 30

22 Enter the amount from line 21 (adjusted gross income). 22

Enter number of

boxes checked 

Check You were 65 or older Blind

if:

23a

Spouse was 65 or older Blind 23a

b

23b

If you are married filing separately and your spouse itemizes

deductions, see page 32 and check here 

Tax,

credits,

and

payments

24 24

25 Subtract line 24 from line 22. If line 24 is more than line 22, enter -0-. 25

26 Multiply $3,000 by the total number of exemptions claimed on line 6d. 26

Subtract line 26 from line 25. If line 26 is more than line 25, enter -0-.

This is your taxable income. 

27

27

28 Tax, including any alternative minimum tax (see page 33). 28

31 Education credits. Attach Form 8863. 31

35

36 Subtract line 35 from line 28. If line 35 is more than line 28, enter -0-. 36

37 Advance earned income credit payments from Form(s) W-2. 37

Add lines 36 and 37. This is your total tax.  38

Federal income tax withheld from Forms W-2

and 1099.

39

39

2002 estimated tax payments and amount

applied from 2001 return. 40

Add lines 39 through 42. These are your total payments.  43

If line 43 is more than line 38, subtract line 38 from line 43.

This is the amount you overpaid.

44

45a

Refund

Amount of line 44 you want applied to your

2003 estimated tax.

46

46

Amount you owe. Subtract line 43 from line 38. For details on how

to pay, see page 48. 

47

47

48 Estimated tax penalty (see page 48). 48

Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my

knowledge and belief, they are true, correct, and accurately list all amounts and sources of income I received during the tax year. Declaration

of preparer (other than the taxpayer) is based on all information of which the preparer has any knowledge.



Enter your standard deduction (see left margin).

Form 1040A (2002)

44

45a Amount of line 44 you want refunded to you. 

38

Credit for child and dependent care expenses.

Attach Schedule 2.

29

29

Adoption credit. Attach Form 8839.

33 33

Retirement savings contributions credit. Attach

Form 8880.

32

32

Credit for the elderly or the disabled. Attach

Schedule 3.

30

35 Add lines 29 through 34. These are your total credits.

40

42

43

Additional child tax credit. Attach Form 8812. 42

Routing

number

Account

number

Checking Savings  b

c

 d

Amount

you owe

Direct

deposit?

See page 47

and fill in

45b, 45c,

and 45d.



41 Earned income credit (EIC). 41

Page 2

Form 1040A (2002)

If you have

a qualifying

child, attach

Schedule

EIC.

Sign

here

Your signature Date

Keep a copy

for your

records.

Spouse’s signature. If a joint return, both must sign. Date

Date Preparer’s SSN or PTIN Preparer’s

signature Check if

self-employed

Paid

preparer’s

use only Firm’s name (or

yours if self-employed),

address, and ZIP code

EIN

Phone no.







Your occupation Joint return?

See page 20.

Daytime phone number

( )

Spouse’s occupation

( )

Single,

$4,700

Head of

household,

$6,900

Married filing

jointly or

Qualifying

widow(er),

$7,850

Married

filing

separately,

$3,925

Standard

Deduction

for—

● People who

checked any

box on line

23a or 23b or

who can be

claimed as a

dependent,

see page 33.

● All others:

Designee’s

name 

Do you want to allow another person to discuss this return with the IRS (see page 49)? Third party

designee Phone

no.  ( )

Yes. Complete the following. No

Personal identification

number (PIN) 

34 34

Child tax credit (see page 36).

Type:
SP-4 Summary

Problems

PROBLEM 2

Capt. Margaret A. Williams, SSN 271-00-6543, a legal assistance

officer, is single. She was transferred from Scott Air Force Base in

Illinois to Andrews Air Force Base in Maryland. On February 8,

2002, she sold her home in Illinois for $132,000. She had originally

bought this home for $76,000 in December 1998. She had lived in

it since January 3, 1999. On March 12, 2002, she bought a new

home at 3219 33rd Ave., Hyattsville, MD 20782, for $110,000. 

She also incurred the following moving expenses:

Transportation of household goods $2,800

(provided in kind by the Air Force)

Travel and lodging en route $ 225

Meals en route $ 125

The Air Force did not reimburse Captain Williams for the travel

expense and she was not eligible to receive a dislocation allowance.

Captain Williams’ Form W-2 shows wages of $36,800. She had

interest income of $175. She knows her BAH is not taxable. She

also had a uniform allowance of $200. She had no other sources of

income. Her federal income tax withheld was $4,200. She has no

dependents. Captain Williams would like to contribute $3 to the

Presidential Election Campaign Fund.

Captain Williams had the following itemized deductions for

the year:

Contributions to church $ 700

Real estate taxes $1,300

Deductible home mortgage interest $6,600

Prepare Captain Williams’ Form 1040, Schedule A, and Form 3903,

Moving Expenses.
SP-5 Summary

Problems

Draft as of

4/23/2002

Department of the Treasury—Internal Revenue Service 1040 U.S. Individual Income Tax Return

For the year Jan. 1–Dec. 31, 2002, or other tax year beginning , 2002, ending , 20 OMB No. 1545-0074

Your first name and initial Last name Your social security number

(See

instructions

on page 19.)

L

A

B

E

L

H

E

R

E

If a joint return, spouse’s first name and initial Last name Spouse’s social security number

Use the IRS

label.

Otherwise,

please print

or type.

Home address (number and street). If you have a P.O. box, see page 19. Apt. no.

City, town or post office, state, and ZIP code. If you have a foreign address, see page 19.

Presidential

Election Campaign

1 Single

Filing Status 2 Married filing jointly (even if only one had income)

Check only

one box.

3

Qualifying widow(er) with dependent child (year

spouse died  ). (See page 19.)

6a Yourself. If your parent (or someone else) can claim you as a dependent on his or her tax

Exemptions return, do not check box 6a

b Spouse

(4) if qualifying

child for child tax

credit (see page 20)

c Dependents: (2) Dependent’s

social security number

(3) Dependent’s

relationship to (1) First name Last name you

If more than five

dependents,

see page 20.

d Total number of exemptions claimed

7 Wages, salaries, tips, etc. Attach Form(s) W-2 7

Income 8a Taxable interest. Attach Schedule B if required 8a

b Tax-exempt interest. Do not include on line 8a 8b Attach

Forms W-2 and

W-2G here.

Also attach

Form(s) 1099-R

if tax was

withheld.

9 Ordinary dividends. Attach Schedule B if required 9

10 Taxable refunds, credits, or offsets of state and local income taxes (see page 22) 10

11 Alimony received 11

12 Business income or (loss). Attach Schedule C or C-EZ 12

Enclose, but do

not attach, any

payment. Also,

please use

Form 1040-V.

13 Capital gain or (loss). Attach Schedule D if required. If not required, check here  13

14 Other gains or (losses). Attach Form 4797 14

15a IRA distributions 15a 15b b Taxable amount (see page 23)

16a Pensions and annuities 16a b Taxable amount (see page 23) 16b

17 Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E 17

18 Farm income or (loss). Attach Schedule F 18

19 Unemployment compensation 19

20a Social security benefits 20a b Taxable amount (see page 25) 20b

21 21

22 Add the amounts in the far right column for lines 7 through 21. This is your total income  22

IRA deduction (see page 27) 24

23

Archer MSA deduction. Attach Form 8853

26

25

One-half of self-employment tax. Attach Schedule SE

27

Self-employed health insurance deduction (see page 30)

26

28

27

Self-employed SEP, SIMPLE, and qualified plans

29

28

Penalty on early withdrawal of savings

30

29

Alimony paid b Recipient’s SSN 

Add lines 23 through 33a 34

30

Subtract line 34 from line 22. This is your adjusted gross income 

31

Adjusted

Gross

Income

35

If you did not

get a W-2,

see page 21. Form

Married filing separately. Enter spouse’s SSN above

and full name here. 

Cat. No. 11320B





Label

Form 1040 (2002)

IRS Use Only—Do not write or staple in this space.

Head of household (with qualifying person). (See page 19.) If

the qualifying person is a child but not your dependent, enter

this child’s name here. 

Other income. List type and amount (see page 27)

Moving expenses. Attach Form 3903

24

25

For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see page 72.

No. of boxes

checked on

6a and 6b

No. of children

on 6c who:

Dependents on 6c

not entered above

Add numbers

on lines

above 

● lived with you

● did not live with

you due to divorce

or separation

(see page 20)

32 32

Student loan interest deduction (see page 28)

31

33a

  Important!

Yes No

Note. Checking “Yes” will not change your tax or reduce your refund.

Do you, or your spouse if filing a joint return, want $3 to go to this fund? 

You must enter

your SSN(s) above.

No Yes

You Spouse

(See page 19.)

(99)

Tuition and fees deduction (see page XX)

34

33a

2002

4

5

35

Educator expenses (see page xx) 23

Form 1040-Pg. 1
SP-6 Summary

Problems

Draft as of

4/23/2002

Itemized deductions (from Schedule A) or your standard deduction (see left margin)

Add lines 62 through 68. These are your total payments 

Form 1040 (2002) Page 2

36 Amount from line 35 (adjusted gross income) 36

37a Check if:

Tax and

Credits

Add the number of boxes checked above and enter the total here  37a

Single,

$4,700

If you are married filing separately and your spouse itemizes deductions, or

you were a dual-status alien, see page 31 and check here 

b

37b

38 38

39 Subtract line 38 from line 36 39

40

If line 36 is $103,000 or less, multiply $3,000 by the total number of exemptions claimed on

line 6d. If line 36 is over $103,000, see the worksheet on page 32

40

41 Taxable income. Subtract line 40 from line 39. If line 40 is more than line 39, enter -0- 41

42 42

46

47

52

Education credits. Attach Form 8863

45

50

Other credits. Check applicable box(es):

49

54

55

Add lines 45 through 53. These are your total credits

49

Subtract line 54 from line 44. If line 54 is more than line 44, enter -0- 

54

Self-employment tax. Attach Schedule SE

55

Other

Taxes

56

70

Social security and Medicare tax on tip income not reported to employer. Attach Form 4137

Tax on qualified plans, including IRAs, and other tax-favored accounts. Attach Form 5329 if required 58

57

59

Add lines 55 through 60. This is your total tax 

60 60

62 Federal income tax withheld from Forms W-2 and 1099 62

63 2002 estimated tax payments and amount applied from 2001 return 63

Payments

64

Amount paid with request for extension to file (see page 51) 67

66

Excess social security and tier 1 RRTA tax withheld (see page 51) 65

67

69

68 Other payments from:

71a 71a

72 72

If line 69 is more than line 61, subtract line 61 from line 69. This is the amount you overpaid

73 73

Amount of line 70 you want refunded to you 

Refund

74

Amount of line 70 you want applied to your 2003 estimated tax 

Estimated tax penalty (see page 52)

Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and

belief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge.

74

You were 65 or older, Blind; Spouse was 65 or older, Blind.

a Form 3800

b Form 8801 c Specify

a Form 2439 b Form 4136

58

Household employment taxes. Attach Schedule H

59

68

Amount

You Owe

Sign

Here Your signature Date

Keep a copy

for your

records.

Spouse’s signature. If a joint return, both must sign. Date

Date Preparer’s SSN or PTIN Preparer’s

signature Check if

self-employed

Paid

Preparer’s

Use Only Firm’s name (or

yours if self-employed),

address, and ZIP code

EIN

Phone no.







Your occupation

Tax (see page 33). Check if any tax is from

Amount you owe. Subtract line 69 from line 61. For details on how to pay, see page 52 

b

Direct deposit?

See page 51

and fill in 71b,

71c, and 71d.

Routing number

Account number

c Checking Savings

a Form(s) 8814 Form 4972

b

d





69

48

45

Retirement savings contributions credit. Attach Form 8880

56

57

Advance earned income credit payments from Form(s) W-2

70



Child tax credit (see page XX)

Credits from:

48

52

50

Additional child tax credit. Attach Form 8812

65

66

Head of

household,

$6,900

Married filing

jointly or

Qualifying

widow(er),

$7,850

Married

filing

separately,

$3,925

Standard

Deduction

for—

Joint return?

See page 19.

Daytime phone number

( )

Earned income credit (EIC)

Credit for the elderly or the disabled. Attach Schedule R

43

44

46

Alternative minimum tax (see page 34). Attach Form 6251

Add lines 42 and 43 

Credit for child and dependent care expenses. Attach Form 2441

47

If you have a

qualifying

child, attach

Schedule EIC.

43

44

64

Spouse’s occupation

( )

Form 1040 (2002)

● People who

checked any

box on line

37a or 37b or

who can be

claimed as a

dependent,

see page 31.

● All others:

Designee’s

name 

Do you want to allow another person to discuss this return with the IRS (see page 53)? Third Party

Designee Phone

no.  ( )

Yes. Complete the following. No

Personal identification

number (PIN) 

53

Foreign tax credit. Attach Form 1116 if required

53

a Form 8396 b Form 8859

51 Adoption credit. Attach Form 8839 51

61 61

Type:

Form 1040-Pg. 2
SP-7 Summary

Problems

Draft as of

5/02/2002

SCHEDULES A&B OMB No. 1545-0074 Schedule A—Itemized Deductions

(Form 1040) (Schedule B is on back)

Department of the Treasury

Internal Revenue Service Attach to Form 1040. See Instructions for Schedules A and B (Form 1040).

Attachment

Sequence No. 07

Name(s) shown on Form 1040 Your social security number

Medical Caution. Do not include expenses reimbursed or paid by others.

and 

Dental

Expenses

Medical and dental expenses (see page A-2) 1 1

2 2

3 Multiply line 2 above by 7.5% (.075) 3

4 Subtract line 3 from line 1. If line 3 is more than line 1, enter -0- 4

State and local income taxes 5 Taxes You 5

Paid Real estate taxes (see page A-2) 6 6

8 Other taxes. List type and amount 

(See

page A-2.)

8

9 Add lines 5 through 8 9

Interest 10 Home mortgage interest and points reported to you on Form 1098

You Paid

10

Home mortgage interest not reported to you on Form 1098. If paid

to the person from whom you bought the home, see page A-3

and show that person’s name, identifying no., and address 

11

(See

page A-3.)

11

12

Points not reported to you on Form 1098. See page A-3

for special rules

12

13 Investment interest. Attach Form 4952 if required. (See

page A-3.) 13

14 Add lines 10 through 13 14

Gifts to 

Charity 15

15 Gifts by cash or check. If you made any gift of $250 or

more, see page A-4

16

Other than by cash or check. If any gift of $250 or more,

see page A-4. You must attach Form 8283 if over $500

16

17 Carryover from prior year 17

18 Add lines 15 through 17 18

19 Casualty or theft loss(es). Attach Form 4684. (See page A-5.)

Casualty and 

Theft Losses 19

Unreimbursed employee expenses—job travel, union

dues, job education, etc. You must attach Form 2106

or 2106-EZ if required. (See page A-5.) 

Job Expenses 20

and Most

Other

Miscellaneous

Deductions

22 Other expenses—investment, safe deposit box, etc. List

type and amount 

(See

page A-5 for

expenses to

deduct here.)

23 Add lines 20 through 22

24 Enter amount from Form 1040, line 36

25 Multiply line 24 above by 2% (.02)

26 Subtract line 25 from line 23. If line 25 is more than line 23, enter -0- 26

Other 27 Other—from list on page A-6. List type and amount 

Miscellaneous

Deductions 27

Total 28

Itemized

Deductions 28

For Paperwork Reduction Act Notice, see Form 1040 instructions. Schedule A (Form 1040) 2002

24

20

22

23

If you made a

gift and got a

benefit for it,

see page A-4.

25

Enter amount from Form 1040, line 36

No. Your deduction is not limited. Add the amounts in the far right column

for lines 4 through 27. Also, enter this amount on Form 1040, line 38.

Yes. Your deduction may be limited. See page A-6 for the amount to enter.

Cat. No. 11330X



Note.

Personal

interest is

not

deductible.



Personal property taxes 7 7

Tax preparation fees 21 21

Is Form 1040, line 36, over $137,300 (over $68,650 if married filing separately)?

(99)

2002

Schedules A& B – Form 1040
SP-8 Summary

Problems

Draft as of

6/14/2002

Moving Expenses OMB No. 1545-0062 Form 3903

Attach to Form 1040.

Department of the Treasury

Internal Revenue Service

Attachment

Sequence No. 62

Name(s) shown on Form 1040 Your social security number

1

1

Enter the amount you paid for travel and lodging expenses in moving from your old home to

your new home. Do not include the cost of meals (see instructions)

2

3 Add lines 1 and 2

Enter the total amount your employer paid you for the expenses listed on lines 1 and 2 that is

not included in the wages box (box 1) of your W-2 form. This amount should be identified with

code P in box 12 of your W-2 form

4

Subtract line 4 from line 3. Enter the result here and on the “Moving expenses” line of

Form 1040. This is your moving expense deduction

5

Enter the amount you paid for transportation and storage of household goods and personal

effects (see instructions)

Before you begin:

2

3

5

4

For Paperwork Reduction Act Notice, see back of form. Cat. No. 12490K Form 3903 (Rev. 10-2002)

Is line 3 more than line 4?

No. You cannot deduct your moving expenses. If line 3 is less than line 4, subtract line 3

from line 4 and include the result on the “Wages, salaries, tips, etc.” line of Form 1040.

General Instructions

Purpose of Form

Use Form 3903 to figure your moving

expense deduction for a move related to

the start of work at a new principal place

of work (workplace). If the new workplace

is outside the United States or its

possessions, you must be a U.S. citizen or

resident alien to deduct your expenses.

For more details, see Pub. 521, Moving

Expenses.

Who May Deduct Moving

Expenses

If you move to a new home because of a

new principal workplace, you may be able

to deduct your moving expenses whether

you are self-employed or an employee. But

you must meet both of the tests explained

next.

Distance Test

Your new principal workplace must be at

least 50 miles farther from your old home

than your old workplace was. For example,

if your old workplace was 3 miles from

your old home, your new workplace must

be at least 53 miles from that home. If you

did not have an old workplace, your new

workplace must be at least 50 miles from

your old home. The distance between the

two points is the shortest of the more

commonly traveled routes between them.

(Rev. October 2002)

A Change To Note

Beginning in 2002, the standard mileage

rate for using your vehicle to move to a

new home is 13 cents a mile.

To see if you meet the

distance test, you can

use the worksheet

below.

Distance Test Worksheet

1. miles

2. miles

3. miles

Is line 3 at least 50 miles?

Yes. You meet this test.

No. You do not meet this test. You cannot deduct your moving expenses. Do not complete Form 3903.

If you qualify to deduct expenses for

more than one move, use a separate Form

3903 for each move.

Enter the number of miles from your old home to your new workplace

Enter the number of miles from your old home to your old workplace

Subtract line 2 from line 1. If zero or less, enter -0-

1.

2.

3.

Yes.

Keep a Copy for Your Records

Members of the armed forces may not have to meet this test.

For details, see the instructions on the back of this form.

 If you are a member of the armed forces, see the instructions to find out how to complete this form.

 See the Distance Test and Time Test in the instructions to find out if you can deduct your moving

expenses.

Form 3903
ASP-1 Summary

Problems

PROBLEM 1

a. Michael and Frieda Adams are allowed an automatic 

extension until June 15 because they are outside the

United States on April 15.

b. See Exhibits P-1 and P-2. (Filled-in Form 1040A)

Note:

■ Sgt. Adams and his wife do not qualify for the earned income

tax credit (EIC) because their taxable earned income and

AGI are each more than $30,201, the 2002 earned income

threshold for married taxpayers filing a joint return, and

their son is a qualifying child.

■ Sgt. Adams and his wife are entitled to the maximum child

tax credit allowed for 2002 ($600) because their AGI for this

purpose is under $110,000. This credit is covered in the

Volunteer Assistor’s Guide. 

IMPORTANT REMINDER:

Since Michael and his wife, Frieda, are filing a 2002 joint

income tax return for the first time, they did not receive an

IRS peel-off label generally mailed to filers. They must write

their names and social security numbers (SSNs) in the label

section of the return.

Because the IRS uses the first name and SSN on a joint return

as a primary account number, it is important that Michael’s

name and social security number always be listed first for consistency in the processing of joint returns.

Social Security numbers must be entered on the Forms 1040,

1040A, and 1040EZ because they are not shown on the

preprinted label.

ANSWERS TO SUMMARY PROBLEMS
ASP-2 Summary

Problems

PROBLEM 2

See Exhibits P-3 through P-6. (Filled-in Form 1040)

Note:

■ Most taxpayers will not have a gain on the sale of their

principal residence over the $250,000 ($500,000 for a married couple filing jointly) exclusion amount. Captain Williams

does not have a taxable gain. Sale of home is discussed 

in lesson 13 of the Volunteer Assistor’s Guide and in

Publication 523, Selling Your Home.

■ Captain Williams’ meal expenses are not deductible 

moving expenses.
Draft as of

6/05/2002

Form Department of the Treasury—Internal Revenue Service

1040A 2002 U.S. Individual Income Tax Return

OMB No. 1545-0085

Your social security number

Your first name and initial Last name Label L

A

B

E

L

H

E

R

E

(See page 19.)

If a joint return, spouse’s first name and initial Last name Spouse’s social security number

Use the

IRS label. Home address (number and street). If you have a P.O. box, see page 20. Apt. no.

You must enter your

SSN(s) above.

City, town or post office, state, and ZIP code. If you have a foreign address, see page 20.

Filing

status

No. of boxes

checked on

6a and 6b

Yourself. If your parent (or someone else) can claim you as a

dependent on his or her tax return, do not check box 6a. Exemptions 6a

b Spouse No. of children

on 6c who: (4) if qualifying

child for child

tax credit (see

page 23)

(2) Dependent’s social

security number

c ● lived with

you

● did not live

with you due

to divorce or

separation

(see page 24)

If more than six

dependents,

see page 22.

Dependents

on 6c not

entered above

d

Add numbers

on lines Total number of exemptions claimed. above

7 Wages, salaries, tips, etc. Attach Form(s) W-2. 7

8a Taxable interest. Attach Schedule 1 if required. 8a

b Tax-exempt interest. Do not include on line 8a. 8b

Attach

Form(s) W-2

here. Also

attach

Form(s)

1099-R if tax

was withheld.

9 Ordinary dividends. Attach Schedule 1 if required. 9

IRA

distributions.

11a Taxable amount

(see page 25).

11b

Enclose, but do

not attach, any

payment.

11a 11b

Taxable amount

(see page 26).

12a Pensions and 12b

annuities. 12a 12b

13 Unemployment compensation and Alaska Permanent Fund dividends. 13

14a Taxable amount

(see page 28).

Social security

benefits.

14b

14a 14b

15 Add lines 7 through 14b (far right column). This is your total income. 15

17 IRA deduction (see page 28). 17

Student loan interest deduction (see page 31).

Income

18

Add lines 16 through 19. These are your total adjustments. 20

Subtract line 20 from line 15. This is your adjusted gross income. 

18

21

Dependents:



Check only

one box.

If you did not

get a W-2, see

page 25.

Form 1040A (2002)

IRS Use Only—Do not write or staple in this space.

(3) Dependent’s

relationship to

(1) First name Last name you

20

21

Adjusted

gross 

income

 Important! 

Cat. No. 11327A

Otherwise,

please print

or type.

For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see page 53.

(99)

10 Capital gain distributions (see page 25). 10

Presidential

Election Campaign

(See page 20.) Yes No

Note. Checking “Yes” will not change your tax or reduce your refund.

Do you, or your spouse if filing a joint return, want $3 to go to this fund? No Yes

You Spouse

19 Tuition and fees deduction (see page XX). 19

1 Single

2 Married filing jointly (even if only one had income)

3

Qualifying widow(er) with dependent child

(year spouse died ). (See page 22.)

Married filing separately. Enter spouse’s SSN above and

full name here. 

Head of household (with qualifying person). (See page 21.)

If the qualifying person is a child but not your dependent,

enter this child’s name here. 

4

5

16 Educator expenses (see page XX). 16

ASP-3 Summary

Problems

Exhibit P-1 Form 1040 A– Pg 1

Michael A. Adams 271 00 3456

Frieda F. Adams 654 00 3217

3145 Aviation Bn

APO New York 09036

x x

John Adams 231 00 6457 son x

2

1

3

33,520 00

40 00

33,560 00

33,560 00

x

x

x
Draft as of

6/05/2002 30

22 Enter the amount from line 21 (adjusted gross income). 22

Enter number of

boxes checked 

Check You were 65 or older Blind

if:

23a

Spouse was 65 or older Blind 23a

b

23b

If you are married filing separately and your spouse itemizes

deductions, see page 32 and check here 

Tax,

credits,

and

payments

24 24

25 Subtract line 24 from line 22. If line 24 is more than line 22, enter -0-. 25

26 Multiply $3,000 by the total number of exemptions claimed on line 6d. 26

Subtract line 26 from line 25. If line 26 is more than line 25, enter -0-.

This is your taxable income. 

27

27

28 Tax, including any alternative minimum tax (see page 33). 28

31 Education credits. Attach Form 8863. 31

35

36 Subtract line 35 from line 28. If line 35 is more than line 28, enter -0-. 36

37 Advance earned income credit payments from Form(s) W-2. 37

Add lines 36 and 37. This is your total tax. 38

Federal income tax withheld from Forms W-2

and 1099.

39

39

2002 estimated tax payments and amount

applied from 2001 return. 40

Add lines 39 through 42. These are your total payments. 43

If line 43 is more than line 38, subtract line 38 from line 43.

This is the amount you overpaid.

44

45a

Refund

Amount of line 44 you want applied to your

2003 estimated tax.

46

46

Amount you owe. Subtract line 43 from line 38. For details on how

to pay, see page 48. 

47

47

48 Estimated tax penalty (see page 48). 48

Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my

knowledge and belief, they are true, correct, and accurately list all amounts and sources of income I received during the tax year. Declaration

of preparer (other than the taxpayer) is based on all information of which the preparer has any knowledge.



Enter your standard deduction (see left margin).

Form 1040A (2002)

44

45a Amount of line 44 you want refunded to you. 

38

Credit for child and dependent care expenses.

Attach Schedule 2.

29

29

Adoption credit. Attach Form 8839.

33 33

Retirement savings contributions credit. Attach

Form 8880.

32

32

Credit for the elderly or the disabled. Attach

Schedule 3.

30

35 Add lines 29 through 34. These are your total credits.

40

42

43

Additional child tax credit. Attach Form 8812. 42

Routing

number

Account

number

Checking Savings b c

d

Amount

you owe

Direct

deposit?

See page 47

and fill in

45b, 45c,

and 45d.



41 Earned income credit (EIC). 41

Page 2

Form 1040A (2002)

If you have

a qualifying

child, attach

Schedule

EIC.

Sign

here

Your signature Date

Keep a copy

for your

records.

Spouse’s signature. If a joint return, both must sign. Date

Date Preparer’s SSN or PTIN Preparer’s

signature

Check if

self-employed Paid

preparer’s

use only

Firm’s name (or

yours if self-employed),

address, and ZIP code

EIN

Phone no.







Your occupation Joint return?

See page 20.

Daytime phone number

( )

Spouse’s occupation

( )

Single,

$4,700

Head of

household,

$6,900

Married filing

jointly or

Qualifying

widow(er),

$7,850

Married

filing

separately,

$3,925

Standard

Deduction

for—

● People who

checked any

box on line

23a or 23b or

who can be

claimed as a

dependent,

see page 33.

● All others:

Designee’s

name 

Do you want to allow another person to discuss this return with the IRS (see page 49)? Third party

designee Phone

no. ( )

Yes. Complete the following. No

Personal identification

number (PIN) 

34 34

Child tax credit (see page 36).

Type:

ASP-4 Summary

Problems

Exhibit P-2 Form 1040A– Pg 2

33,560 00

7,850 00

25,710 00

9,000 00

16,710 00

1,909 00

1,309 00

1,309 00

2,500 00

1,191 00

1,191 00

2,500 00

Michael A. Adams 4-15-03 US Army, Active

Frieda F. Adams 4-15-03 Homemaker

600 00

600 00
ASP-5 Summary

Problems

Exhibit P-3 Form 1040 – Pg 1

Draft as of

4/23/2002

Department of the Treasury—Internal Revenue Service 1040 U.S. Individual Income Tax Return

For the year Jan. 1–Dec. 31, 2002, or other tax year beginning , 2002, ending , 20 OMB No. 1545-0074

Your first name and initial Last name Your social security number

(See

instructions

on page 19.)

L

A

B

E

L

H

E

R

E

If a joint return, spouse’s first name and initial Last name Spouse’s social security number

Use the IRS

label.

Otherwise,

please print

or type.

Home address (number and street). If you have a P.O. box, see page 19. Apt. no.

City, town or post office, state, and ZIP code. If you have a foreign address, see page 19.

Presidential

Election Campaign

1 Single

Filing Status 2 Married filing jointly (even if only one had income)

Check only

one box.

3

Qualifying widow(er) with dependent child (year

spouse died ). (See page 19.)

6a Yourself. If your parent (or someone else) can claim you as a dependent on his or her tax

Exemptions return, do not check box 6a

b Spouse

(4) if qualifying

child for child tax

credit (see page 20)

c Dependents: (2) Dependent’s

social security number

(3) Dependent’s

relationship to (1) First name Last name you

If more than five

dependents,

see page 20.

d Total number of exemptions claimed

7 Wages, salaries, tips, etc. Attach Form(s) W-2 7

Income 8a Taxable interest. Attach Schedule B if required 8a

b Tax-exempt interest. Do not include on line 8a 8b Attach 

Forms W-2 and

W-2G here.

Also attach

Form(s) 1099-R

if tax was

withheld.

9 Ordinary dividends. Attach Schedule B if required 9

10 Taxable refunds, credits, or offsets of state and local income taxes (see page 22) 10

11 Alimony received 11

12 Business income or (loss). Attach Schedule C or C-EZ 12

Enclose, but do

not attach, any

payment. Also,

please use

Form 1040-V.

13 Capital gain or (loss). Attach Schedule D if required. If not required, check here 13

14 Other gains or (losses). Attach Form 4797 14

15a IRA distributions 15a 15b b Taxable amount (see page 23)

16a Pensions and annuities 16a b Taxable amount (see page 23) 16b

17 Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E 17

18 Farm income or (loss). Attach Schedule F 18

19 Unemployment compensation 19

20a Social security benefits 20a b Taxable amount (see page 25) 20b

21 21

22 Add the amounts in the far right column for lines 7 through 21. This is your total income 22

IRA deduction (see page 27) 24

23

Archer MSA deduction. Attach Form 8853

26

25

One-half of self-employment tax. Attach Schedule SE

27

Self-employed health insurance deduction (see page 30)

26

28

27

Self-employed SEP, SIMPLE, and qualified plans

29

28

Penalty on early withdrawal of savings

30

29

Alimony paid b Recipient’s SSN 

Add lines 23 through 33a 34

30

Subtract line 34 from line 22. This is your adjusted gross income 

31

Adjusted

Gross

Income

35

If you did not

get a W-2,

see page 21. Form

Married filing separately. Enter spouse’s SSN above

and full name here. 

Cat. No. 11320B





Label

Form 1040 (2002)

IRS Use Only—Do not write or staple in this space.

Head of household (with qualifying person). (See page 19.) If

the qualifying person is a child but not your dependent, enter

this child’s name here. 

Other income. List type and amount (see page 27)

Moving expenses. Attach Form 3903

24

25

For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see page 72.

No. of boxes

checked on

6a and 6b

No. of children

on 6c who:

Dependents on 6c

not entered above

Add numbers

on lines

above 

● lived with you

● did not live with

you due to divorce

or separation

(see page 20)

32 32

Student loan interest deduction (see page 28)

31

33a

  Important!

Yes No

Note. Checking “Yes” will not change your tax or reduce your refund.

Do you, or your spouse if filing a joint return, want $3 to go to this fund? 

You must enter

your SSN(s) above.

No Yes

You Spouse

(See page 19.)

(99)

Tuition and fees deduction (see page XX)

34

33a

2002

4

5

35

Educator expenses (see page xx) 23

Margaret A. Williams 271 00 6543

3219 33rd Avenue

Hyattsville, MD 20782

1

1

36,800 00

175 00

36,975 00

225 00

36,750 00

225 00

X

X

X
Draft as of

4/23/2002

Itemized deductions (from Schedule A) or your standard deduction (see left margin)

Add lines 62 through 68. These are your total payments 

Form 1040 (2002) Page 2

36 Amount from line 35 (adjusted gross income) 36

37a Check if:

Tax and

Credits

Add the number of boxes checked above and enter the total here 37a

Single,

$4,700

If you are married filing separately and your spouse itemizes deductions, or

you were a dual-status alien, see page 31 and check here 

b

37b

38 38

39 Subtract line 38 from line 36 39

40

If line 36 is $103,000 or less, multiply $3,000 by the total number of exemptions claimed on

line 6d. If line 36 is over $103,000, see the worksheet on page 32

40

41 Taxable income. Subtract line 40 from line 39. If line 40 is more than line 39, enter -0- 41

42 42

46

47

52

Education credits. Attach Form 8863

45

50

Other credits. Check applicable box(es):

49

54

55

Add lines 45 through 53. These are your total credits

49

Subtract line 54 from line 44. If line 54 is more than line 44, enter -0- 

54

Self-employment tax. Attach Schedule SE

55

Other

Taxes

56

70

Social security and Medicare tax on tip income not reported to employer. Attach Form 4137

Tax on qualified plans, including IRAs, and other tax-favored accounts. Attach Form 5329 if required 58

57

59

Add lines 55 through 60. This is your total tax 

60 60

62 Federal income tax withheld from Forms W-2 and 1099 62

63 2002 estimated tax payments and amount applied from 2001 return 63

Payments

64

Amount paid with request for extension to file (see page 51) 67

66

Excess social security and tier 1 RRTA tax withheld (see page 51) 65

67

69

68 Other payments from:

71a 71a

72 72

If line 69 is more than line 61, subtract line 61 from line 69. This is the amount you overpaid

73 73

Amount of line 70 you want refunded to you 

Refund

74

Amount of line 70 you want applied to your 2003 estimated tax 

Estimated tax penalty (see page 52)

Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and

belief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge.

74

You were 65 or older, Blind; Spouse was 65 or older, Blind.

a Form 3800

b Form 8801 c Specify

a Form 2439 b Form 4136

58

Household employment taxes. Attach Schedule H

59

68

Amount

You Owe

Sign

Here Your signature Date

Keep a copy

for your

records.

Spouse’s signature. If a joint return, both must sign. Date

Date Preparer’s SSN or PTIN Preparer’s

signature Check if

self-employed

Paid

Preparer’s

Use Only Firm’s name (or

yours if self-employed),

address, and ZIP code

EIN

Phone no.







Your occupation

Tax (see page 33). Check if any tax is from

Amount you owe. Subtract line 69 from line 61. For details on how to pay, see page 52 

b

Direct deposit?

See page 51

and fill in 71b,

71c, and 71d.

Routing number

Account number

c Checking Savings

a Form(s) 8814 Form 4972

b

d





69

48

45

Retirement savings contributions credit. Attach Form 8880

56

57

Advance earned income credit payments from Form(s) W-2

70



Child tax credit (see page XX)

Credits from:

48

52

50

Additional child tax credit. Attach Form 8812

65

66

Head of

household,

$6,900

Married filing

jointly or

Qualifying

widow(er),

$7,850

Married

filing

separately,

$3,925

Standard

Deduction

for—

Joint return?

See page 19.

Daytime phone number

( )

Earned income credit (EIC)

Credit for the elderly or the disabled. Attach Schedule R

43

44

46

Alternative minimum tax (see page 34). Attach Form 6251

Add lines 42 and 43 

Credit for child and dependent care expenses. Attach Form 2441

47

If you have a

qualifying

child, attach

Schedule EIC.

43

44

64

Spouse’s occupation

( )

Form 1040 (2002)

● People who

checked any

box on line

37a or 37b or

who can be

claimed as a

dependent,

see page 31.

● All others:

Designee’s

name 

Do you want to allow another person to discuss this return with the IRS (see page 53)? Third Party

Designee Phone

no. ( )

Yes. Complete the following. No

Personal identification

number (PIN) 

53

Foreign tax credit. Attach Form 1116 if required

53

a Form 8396 b Form 8859

51 Adoption credit. Attach Form 8839 51

61 61

Type:

ASP-6 Summary

Problems

Exhibit P-4 Form 1040 – Pg 2

36,750 00

8,600 00

28,150 00

3,000 00

25,150 00

3,476 00

3,476 00

3,476 00

3,476 00

4,200 00

724 00

724 00

Margaret A. Williams 3/20/03 U.S. Air Force

4,200 00
ASP-7 Summary

Problems

Exhibit P-5 Schedules A & B (Form 1040)

Draft as of

5/02/2002

SCHEDULES A&B OMB No. 1545-0074 Schedule A— Itemized Deductions

(Form 1040) (Schedule B is on back)

Department of the Treasury

Internal Revenue Service Attach to Form 1040. See Instructions for Schedules A and B (Form 1040).

Attachment

Sequence No. 07

Name(s) shown on Form 1040 Your social security number

Medical Caution. Do not include expenses reimbursed or paid by others.

and 

Dental

Expenses

1 Medical and dental expenses (see page A-2) 1

2 2

3 Multiply line 2 above by 7.5% (.075) 3

4 Subtract line 3 from line 1. If line 3 is more than line 1, enter -0- 4

Taxes You 5 State and local income taxes 5

Paid 6 Real estate taxes (see page A-2) 6

8 Other taxes. List type and amount 

(See

page A-2.)

8

9 Add lines 5 through 8 9

Interest 10 Home mortgage interest and points reported to you on Form 1098

You Paid

10

Home mortgage interest not reported to you on Form 1098. If paid

to the person from whom you bought the home, see page A-3

and show that person’s name, identifying no., and address 

11

(See

page A-3.)

11

12

Points not reported to you on Form 1098. See page A-3

for special rules

12

13 Investment interest. Attach Form 4952 if required. (See

page A-3.) 13

14 Add lines 10 through 13 14

Gifts to 

Charity 15

15 Gifts by cash or check. If you made any gift of $250 or

more, see page A-4

16

Other than by cash or check. If any gift of $250 or more,

see page A-4. You must attach Form 8283 if over $500

16

17 Carryover from prior year 17

18 Add lines 15 through 17 18

19 Casualty or theft loss(es). Attach Form 4684. (See page A-5.)

Casualty and 

Theft Losses 19

Unreimbursed employee expenses—job travel, union

dues, job education, etc. You must attach Form 2106

or 2106-EZ if required. (See page A-5.) 

Job Expenses 20

and Most

Other

Miscellaneous

Deductions

22 Other expenses—investment, safe deposit box, etc. List

type and amount 

(See

page A-5 for

expenses to

deduct here.)

23 Add lines 20 through 22

24 Enter amount from Form 1040, line 36

25 Multiply line 24 above by 2% (.02)

26 Subtract line 25 from line 23. If line 25 is more than line 23, enter -0- 26

Other 27 Other—from list on page A-6. List type and amount 

Miscellaneous

Deductions 27

Total 28

Itemized

Deductions 28

For Paperwork Reduction Act Notice, see Form 1040 instructions. Schedule A (Form 1040) 2002

24

20

22

23

If you made a

gift and got a

benefit for it,

see page A-4.

25

Enter amount from Form 1040, line 36

No. Your deduction is not limited. Add the amounts in the far right column

for lines 4 through 27. Also, enter this amount on Form 1040, line 38.

Yes. Your deduction may be limited. See page A-6 for the amount to enter.

Cat. No. 11330X



Note.

Personal

interest is

not

deductible.



7 Personal property taxes 7

21 Tax preparation fees 21

Is Form 1040, line 36, over $137,300 (over $68,650 if married filing separately)?

(99)

2002

1,300 00

1,300 00

6,600 00

6,600 00

700 00

700 00

8,600 00

Margaret A. Williams 271 00 6543
ASP-8 Summary

Problems

Exhibit P-6 Form 3903

Draft as of

6/14/2002

Moving Expenses OMB No. 1545-0062 Form 3903

Attach to Form 1040.

Department of the Treasury

Internal Revenue Service

Attachment

Sequence No. 62

Name(s) shown on Form 1040 Your social security number

1

1

Enter the amount you paid for travel and lodging expenses in moving from your old home to

your new home. Do not include the cost of meals (see instructions)

2

3 Add lines 1 and 2

Enter the total amount your employer paid you for the expenses listed on lines 1 and 2 that is

not included in the wages box (box 1) of your W-2 form. This amount should be identified with

code P in box 12 of your W-2 form

4

Subtract line 4 from line 3. Enter the result here and on the “Moving expenses” line of

Form 1040. This is your moving expense deduction

5

Enter the amount you paid for transportation and storage of household goods and personal

effects (see instructions)

Before you begin:

2

3

5

4

For Paperwork Reduction Act Notice, see back of form. Cat. No. 12490K Form 3903 (Rev. 10-2002)

Is line 3 more than line 4?

No. You cannot deduct your moving expenses. If line 3 is less than line 4, subtract line 3

from line 4 and include the result on the “Wages, salaries, tips, etc.” line of Form 1040.

General Instructions

Purpose of Form

Use Form 3903 to figure your moving

expense deduction for a move related to

the start of work at a new principal place

of work (workplace). If the new workplace

is outside the United States or its

possessions, you must be a U.S. citizen or

resident alien to deduct your expenses.

For more details, see Pub. 521, Moving

Expenses.

Who May Deduct Moving

Expenses

If you move to a new home because of a

new principal workplace, you may be able

to deduct your moving expenses whether

you are self-employed or an employee. But

you must meet both of the tests explained

next.

Distance Test

Your new principal workplace must be at

least 50 miles farther from your old home

than your old workplace was. For example,

if your old workplace was 3 miles from

your old home, your new workplace must

be at least 53 miles from that home. If you

did not have an old workplace, your new

workplace must be at least 50 miles from

your old home. The distance between the

two points is the shortest of the more

commonly traveled routes between them.

(Rev. October 2002)

A Change To Note

Beginning in 2002, the standard mileage

rate for using your vehicle to move to a

new home is 13 cents a mile.

To see if you meet the

distance test, you can

use the worksheet

below.

Distance Test Worksheet

1. miles

2. miles

3. miles

Is line 3 at least 50 miles?

Yes. You meet this test.

No. You do not meet this test. You cannot deduct your moving expenses. Do not complete Form 3903.

If you qualify to deduct expenses for

more than one move, use a separate Form

3903 for each move.

Enter the number of miles from your old home to your new workplace

Enter the number of miles from your old home to your old workplace

Subtract line 2 from line 1. If zero or less, enter -0-

1.

2.

3.

Yes.

Keep a Copy for Your Records

Members of the armed forces may not have to meet this test.

For details, see the instructions on the back of this form.

 If you are a member of the armed forces, see the instructions to find out how to complete this form.

 See the Distance Test and Time Test in the instructions to find out if you can deduct your moving

expenses.

Margaret A. Williams 271 00 6543

0 00

225 00

225 00

225 00

X
Answer Yes or No to the following questions.

1. Is Imminent Danger Pay taxable? 

2. Charlie Becker was separated from service due to a medical

condition. He was given $32,000 of medical separation pay

in 2001. He included this amount on his 2001 tax return.

The VA determines in 2002, that due to his medical condition

he is entitled to a VA disability pension. Should he amend

his 2001 return? 

3. Is Yemen considered a “designated combat zone”? 

4. Are student loan repayments that are attributable to the

period of service in the combat zone excludible from income? 

5. Harry is in the air force and is stationed in Germany. His

only income is his military pay. Does he qualify for the foreign earned income exclusion? 

6. Julie has been serving in a combat zone since October 2002.

Does her 2002 federal income tax return have to be filed by

4-15-03? 

7. David died while serving in a combat zone. Can his federal

income tax liability be forgiven? 

8. Maria is married to Bob Smith who is an airman in the U.S.

Air Force. They live in Germany where Maria holds her citizenship. Can she file a joint return with Bob? 

9. If Maria files a joint return with Bob, can she list only her

U.S. sourced income on the joint tax return? 

10. For Head of Household purposes are you considered unmarried if your spouse was a nonresident alien at any time during the year (and you do not choose to treat your spouse as

a resident alien)? 

11. Sally, who is 18, has been in the military all year. Can her

mom claim her as a dependent? 

12. Can Herman claim his mother (who is a citizen and resident of Austria) on his return? 

13. Charlotte is not eligible for a Social Security number. She is

filing a joint return with a U.S. citizen. Does she need to

apply for an ITIN? 

Test T-1

COMPREHENSIVE TEST

QUESTIONS FOR

MILITARY ISSUES 




T-2 Test

14. Does personal property tax paid to a foreign government

qualify for the Foreign Tax Credit? 

15. Do you include BAS and BAH in the calculation of earned

income for purposes of the earned income credit? 

16. Madison sold her house and made $46,000. She had lived in

the house as her main home for the last 3 years. Does she

have to pay tax on this gain? 

17. Brent had moving costs associated with a permanent

change of station. Can he deduct the moving costs (that are

not reimbursed)? 

18. Lori is in the reserves and she attends training and drills

every month that require her to incur travel costs. Can

Lori deduct the unreimbursed travel expenses on her tax

return? 

19. Is the cost of maintaining uniforms that can be worn offduty eligible for a tax deduction? 

20. Gloria paid $200 to attend an accounting class at a qualified institution. Can she take this amount as an adjustment to income? 

21. Is a coach (who does not teach) considered an eligible educator? 

22. Richard is in the military. His wife works for a local manufacturer. They are both considered to be covered by a pension plan. Their AGI is $66,000 and they each contributed

$2,000 to a traditional IRA. Can they deduct their IRA contributions on their tax return? 

23. Airman Jones had business income of $50,000 and business

expenses of $3,500. Can he file Schedule C-EZ? 

24. Pvt. Dodd has net income of $394 on his Schedule C-EZ.

Does he need to file a Schedule SE? 

25. Larry rents out his former home. Should he report the

income and expenses on Schedule E?
1. 14.

2. 15.

3. 16.

4. 17.

5. 18.

6. 19.

7. 20.

8. 21.

9. 22.

10. 23.

11. 24.

12. 25.

13.

Test T-3

COMPREHENSIVE TEST ANSWER

SHEET FOR MILITARY ISSUES 




T-4 Test

1. Yes 14. No

2. Yes 15. No

3. Yes 16. No

4. Yes 17. Yes

5. No 18. Yes

6. No 19. No

7. Yes 20. Yes

8. Yes 21. No

9. No 22. No

10. Yes 23. No

11. No 24. No

12. No 25. Yes

13. Yes

COMPREHENSIVE TEST ANSWER

ANSWERS TO TEST SHEET FOR MILITARY ISSUES