Page 1 GAO-04-721R Military Compensation 

United States General Accounting Office

Washington, DC 20548 

May 7, 2004 

The Honorable Charles E. Grassley 

Chairman 

The Honorable Max S. Baucus 

Ranking Minority Member 

Committee on Finance 

United States Senate 

The Honorable Mark Pryor 

United States Senate 

Subject: Military Personnel: Active Duty Compensation and Its Tax Treatment 

The Department of Defense’s (DOD) total military compensation package for active 

duty members consists of both cash and noncash benefits. Since the late 1990s, 

Congress and the DOD have increased military cash compensation by increasing 

basic pay and allowances for housing, among other things. Military members also 

receive tax breaks, which are a part of their cash compensation. Moreover, active 

duty personnel are offered substantial noncash benefits, such as retirement, health 

care, commissaries, and childcare. In some cases, these noncash benefits exceed 

those available to private-sector personnel.1

 DOD relies heavily on noncash benefits 

because it views benefits as critical to morale, retention, and the quality of life for 

service members and their families. 

To better understand the military compensation system, you asked us to provide you 

information on active duty military compensation and its tax treatment. At the outset 

of this engagement, we agreed to keep you periodically informed of the status of our 

work. In January 2004, we briefed your staff on our preliminary observations. 

Because our work identified that the combat zone tax exclusion2

 could impact some 

service members, you asked us to focus our work on military cash compensation and 

to do additional work to estimate the effect of the combat zone tax exclusion on 

service members’ compensation. We provided your staff subsequent briefings that 

estimated the effect of the combat zone exclusion. As requested, we have updated 

and combined the briefings for this report to (1) summarize active duty cash 

compensation and describe how military compensation varies at different career 

 

1

 U.S. General Accounting Office, Military Personnel: Active Duty Benefits Reflect Changing 

Demographics, but Opportunities Exist to Improve, GAO-02-935 (Washington, D.C.: Sept. 18, 2002). 2

 The combat zone exclusion allows service members to exclude income earned for each month served 

in one of the 15 designated combat zones. Members who serve a minimum of 1 day in a combat zone 

are eligible to receive the combat zone exclusion for the respective month. For officers, the combat 

zone exclusion was limited to $5,958 per month in 2003. Enlisted members’ exclusion is not limited. 
Page 2 GAO-04-721R Military Compensation

points for officers and enlisted members; (2) explain how military pay is taxed and 

any special tax treatment of military compensation; (3) estimate the effects of 

interactions between the combat zone exclusion and certain tax credits on military 

members’ compensation; and (4) describe the benefits DOD provides active duty 

members as well as specific programs available to members that encourage wealth 

building (see enclosure I). To provide a rough estimate of the number of service 

members in 2003 who suffered a net tax loss because of the interactions between 

serving in a combat zone and certain tax credits, we used aggregate data compiled by 

the Defense Manpower Data Center on the number of members who served in a 

combat zone in 2003 and aggregate data on the percentage of spouses not in the 

workforce from the 2002 Active Duty Survey. We believe that the data is sufficiently 

reliable to estimate within a broad range the number of people affected. We 

conducted our review from October 2003 through April 2004 in accordance with 

generally accepted government auditing standards. 

 

Results in Brief 

The foundation of military cash compensation is what the DOD calls regular military 

compensation—the sum of basic pay, nontaxable allowances for housing and 

subsistence, and the associated federal tax savings. Some members also receive 

additional cash compensation in the form of special pays, incentives, and other 

allowances. In total, there are over 50 of these pays, incentives, and allowances, 

ranging from reenlistment bonuses to clothing allowances and family separation 

allowances. The annual amounts of these pays, incentives, and allowances range 

from a few hundred dollars to thousands of dollars, and some of these are also 

nontaxable. In general, regular military compensation progresses steadily with pay 

grade and years of service. For example, a junior enlisted member with 3 years of 

service might earn around $40,000 in cash compensation, while a senior officer with 

22 years of service could earn cash compensation of about $130,000. 

Military service brings with it significant tax advantages. Basic pay and most other 

pays are generally subject to federal income tax; however, certain allowances are not 

taxed, such as the basic allowances for housing and subsistence. 3 DOD considers the 

federal tax advantage as the additional income military members would have to earn 

in order to receive their current take-home pay if their allowances for housing and 

subsistence were taxable. In fact, DOD views the federal tax advantage as part of 

service members’ cash compensation when it compares military pay with civilian pay. 

In addition, pay earned—including basic pay, bonuses, special pays, and 

allowances—while members are serving in one of the 15 designated combat zones is 

excluded from taxes. 

The complex interactions between the combat zone exclusion and certain tax credits 

(principally the Earned Income Tax Credit and the Additional Child Tax Credit) 

appear to be creating unintended consequences. Specifically, some low-income- 

 

3

 Although the allowances for housing and subsistence are the primary nontaxable allowances and 

account for most of service members’ tax benefit, some members may receive other nontaxable 

allowances, such as the family separation allowance—that is, additional money provided to service 

members as compensation for being away from their spouses and/or children. 
Page 3 GAO-04-721R Military Compensation

earning service members who serve in a combat zone are worse off for tax purposes, 

while some higher-income-earning members are better off because they become 

eligible for a tax credit that is normally targeted to low-income workers. Low-income 

members with children qualify for refundable tax credits that can not only offset all 

of their tax liability but can also leave them with payments from the government. The 

combat zone exclusion can actually cause a reduction or elimination of these 

payments to some service members. For example, over certain income ranges the 

amount of Earned Income Tax Credit that a taxpayer earns increases as his or her 

income increases. Service in a combat zone reduces the amount of earned income 

that a member reports for tax purposes and, thus, can reduce or eliminate the 

refunded portion of the member’s credit. These members actually suffer a net loss in 

tax benefits because they receive no offsetting advantage from the exclusion. Our 

analysis suggests that some of the roughly 430,000 members serving in a combat zone 

in 2003—between 5,000 and 10,000 members in one-earner households—suffered a 

net loss of tax benefits.4 Data limitations make it difficult to produce a 

comprehensive estimate of the number of members who suffered a net loss of tax 

benefits. In particular, it is more difficult to make a reliable estimate of the number 

of members with working spouses who had net losses of tax benefits. However, we 

believe that number is not likely to be much higher than several thousand and could 

be less than that. Additionally, the number of members losing tax benefits could be 

larger in 2004 depending on the how many service members are in a combat zone and 

how long they are there. The amount of the tax benefit loss varies considerably, with 

a maximum of about $4,500 or $3,200, for enlisted and officer members, respectively. 

In general, the members losing tax benefits tend to be those who are serving in a 

combat zone longer than 6 months; who are in the lower pay grades; who are married 

with children; and who have little to no investment or spousal income. On the other 

hand, some other low-income members earned larger earned income tax credits by 

serving in a combat zone than they otherwise would have. Moreover, it appears that 

a large number of service members who had incomes exceeding the normal upper 

limit for Earned Income Tax Credit eligibility and who served in a combat zone for at 

least 6 months could become eligible to receive that credit as a result of this income 

exclusion. DOD is aware of service members who are disadvantaged and advantaged 

by these tax provisions, and it is seeking remedies that would require changing the 

rules of the tax credits so that income earned in a combat zone would not be 

excluded when calculating eligibility for the tax credits. 

Benefits are a substantial portion of noncash military compensation. DOD offers a 

wide range of benefits to active duty members, including health care, retirement, 

education assistance, and installation-based benefits—that is, services found on 

military installations, such as commissaries and child care. While the value of 

benefits to members varies depending on the members’ needs, the cost to provide 

such benefits is substantial. 5 Some of the benefits DOD provides encourage wealth 

 

4

 Our estimates are based on information provided by DOD on the number of households with a spouse 

not in the labor force, the amount of military members’ pay, and the 2003 deployment rates. They are 

also based on the assumption that deployed personnel in each pay grade have the same household 

characteristics as the total population of service members in each grade. These estimates are 

imprecise because we did not have information such as total family income, deductions, and other tax 

credits. See enclosure II for further details on our methodology. 

5

 According to a recent Congressional Budget Office report, noncash benefits in 2002 cost an average 

of $56,000 per active duty service member. However, this cost includes noncash compensation that 
Page 4 GAO-04-721R Military Compensation

building over a service member’s career. Military retirement—a lifetime annuity 

generally provided to members who serve 20 years or more—is one of the primary 

wealth-building programs available to military members. However, DOD estimates 

that less than half of officers and only about 15 percent of enlisted members will 

become eligible for retirement. In addition, other savings programs are offered, such 

as the Thrift Savings Plan and the Savings Deposit Program. Since 2001, service 

members can contribute a percentage of their basic pay, before taxes, to be invested 

in one or more of the specific funds offered through the Thrift Savings Plan; about 21 

percent of the active duty military participate. Service members deployed to a 

combat zone or other qualified areas can contribute to the Savings Deposit Program, 

earning a guaranteed 10 percent interest on their investment. 6 However, less than 1 

percent of the active duty force participates. Service members may also be eligible to 

participate in the Department of Veterans Affairs no-money down, mortgage-backed 

loan program. Moreover, military members can take advantage of a number of 

wealth-building tax provisions available to citizens, such as deductions for mortgage 

interest and tax credits for elective retirement accounts contributions. 

Matter for Congressional Consideration 

If the Congress wishes to remedy the unintended tax consequences associated with 

the combat zone exclusion, it should consider revising the rules of the Earned 

Income Tax Credit and the Additional Child Tax Credit with respect to income earned 

in a combat zone. 

Scope and Methodology 

Our audit work focused on military cash compensation and its tax treatment for 

active duty service members. To summarize the components of active duty military 

members’ compensation, we reviewed policies, publications, and regulations 

governing military compensation. We interviewed officials from the Office of the 

Secretary of Defense and the Defense Manpower Data Center. We compiled 2003 

data for basic pay tables, basic allowances for housing and subsistence rates, special 

pay amounts, incentive pay amounts, and allowance pay amounts. To describe how 

military compensation varies at different career points for officers and enlisted 

members, we created notional junior and senior enlisted service members and 

officers. We assigned these hypothetical service members typical years of service for 

their pay grades, locations across the United States, numbers of dependents, and 

special pays typical of their pay grades and locations. We discussed our examples 

with officials from the Office of the Under Secretary of Defense for Personnel and 

Readiness to ensure that our profiles were reasonable. We identified benefits offered 

to active duty military members and some associated values by reviewing past GAO 

reports, DOD documents, and the fiscal year 2002 DOD Actuarial Valuation Report. 

 service members receive while on active duty and estimated accrued cost of deferred compensation 

for the following noncash benefits: health care for service members, their dependents, and retirees; 

veterans’ services; and other benefits, such as the Social Security Old-Age and Survivors Insurance and 

Disability Insurance programs. Also, this cost includes installation-based services for active duty 

members. Congressional Budget Office, Military Compensation: Balancing Cash and Noncash 

Benefits (Washington, D.C.: Jan. 16, 2004). 6

 Members deployed to combat zones, qualified hazardous duty areas, or certain contingency 

operations are eligible to participate in the Savings Deposit Program. 
Page 5 GAO-04-721R Military Compensation

To explain how military pay is taxed and any special tax treatment of military 

compensation, we reviewed DOD policies and regulations and the Internal Revenue 

Services’ 2003 Armed Forces Tax Guide publication. To estimate the federal tax 

advantage of the exclusion of the housing and subsistence allowances from taxation, 

we estimated the tax liability for hypothetical members according to current tax rules 

as if the members’ housing and subsistence allowances were taxable. We present the 

pre-tax value of this tax advantage—that is, the additional income the members 

would have to earn in order to receive their current take home pay if their allowances 

were taxable. 

To estimate certain effects of the combat zone exclusion on military members’ taxes, 

we estimated the number of members negatively affected and the number who may 

become eligible for Earned Income Tax Credit by the combat zone tax exclusion. For 

more detailed information on how we estimated the combat zone effect, see 

enclosure II. 

 

To describe programs available to members that encourage wealth building, we 

reviewed documents and interviewed officials from the Office of the Secretary of 

Defense and the Department of Veterans Affairs. In addition, we also reviewed other 

documents to identify tax provisions that encourage wealth building for citizens. 

Agency Comments 

In providing oral comments on a draft of this report, DOD representatives from the 

Office of the Under Secretary of Defense for Personnel and Readiness stated that 

they generally concurred with the content of the report. Technical comments were 

incorporated as appropriate. DOD officials told us that they have been seeking to 

remedy the unintended tax consequence related to the combat zone tax exclusion. 

We also received comments on the tax-related sections of our draft from Internal 

Revenue Service (IRS). In providing oral comments, IRS representatives from the 

Office of the Commissioner, Wage and Investment Division and the Office of 

Legislative Affairs said that the IRS could administer a change in law that would 

include combat pay in earned income for purposes of computing eligibility for the 

Earned Income Tax Credit. Since earned income used for computing Earned Income 

Tax Credit is not reported anywhere on the IRS form 1040 or Schedule EIC, IRS 

would modify the Earned Income Tax Credit worksheets and related instructions to 

account for the combat zone pay. In addition, they would work with DOD to develop 

a process for identifying and processing returns from taxpayers who would be 

affected by this provision. The representatives noted that, although at the outset the 

process would likely be primarily manual, IRS would explore options for automation. 

The IRS officials also provided technical comments relating to the child tax credit, 

which we incorporated as appropriate, and made the point that changes to the 

treatment of income earned in a combat zone for the purposes of the two credits 

could affect other tax benefits, such as the dependent care credit and the exclusion 

for employer-provided benefits under a dependent care assistance program, 

depending on the specific wording of the changes. We also spoke to the Department 

of Treasury staff about the tax-related sections of our briefing documents and 

incorporated their technical comments as appropriate. 
Page 6 GAO-04-721R Military Compensation

- - - - - - 

As arranged with your office, unless you publicly announce its contents earlier, we 

plan no further distribution of this report until 30 days from its issue date. At that 

time, we will send copies of this report to the Secretary of Defense and the 

Commissioner of the Internal Revenue Service. We will also make copies available to 

appropriate congressional committees and to other interested parties on request. In 

addition, the report will be available at no charge on our Web site at 

http://www.gao.gov. 

If you or your staff have any questions about this report, please contact Derek 

Stewart, (202) 512-5559, or James White, (202) 512-5594, or e-mail them at 

stewartd@gao.gov or whitej@gao.gov, respectively. Key contributors to this report 

were Lori Atkinson, Jennifer Gravelle, John Pendleton, Sonja Ware, and James 

Wozny. 

Derek B. Stewart 

Director, Defense Capabilities and Management 

James R. White, 

Director, Strategic Issues 
Enclosure I 

Page 7 GAO-04-721R Military Compensation

1

Active Duty Military 

Compensation and Its Tax 

Treatment 
Enclosure I 

Page 8 GAO-04-721R Military Compensation

2

Objectives

• Summarize the components of active duty military members’ cash 

compensation and describe how military compensation varies at different 

career points for officers and enlisted members. 

• Explain how military pay is taxed and any special tax treatment of military 

compensation. 

• Estimate the effects of interactions between the combat zone exclusion 

and certain tax credits on military members’ compensation.

• Describe the benefits the Department of Defense (DOD) provides active 

duty members as well as specific programs available to military members 

that encourage wealth building.
Enclosure I 

Page 9 GAO-04-721R Military Compensation

3

Results in Brief

• The foundation of military cash compensation is what DOD calls “regular military 

compensation”—comprised of basic pay, allowances for housing and subsistence, 

and federal tax advantages. Some members also receive special pays, such as 

reenlistment bonuses, and other allowances. Military compensation progresses 

steadily with seniority. For example, a junior enlisted member with 3 years of 

service might earn around $40,000 in cash compensation, while a senior officer with 

22 years of service could earn cash compensation of about $130,000 per year. 

• Basic pay and some other pays are taxed; however, certain allowances, such as 

those for housing and subsistence, are not taxed. Additionally, income earned—

including special pays, bonuses, or allowances— while serving in a combat zone is 

not taxed. 

• Although most of the roughly 430,000 members who served in a combat zone in 

2003 benefited from excluding their earned income for taxes, some lower-income 

members were actually worse off, because income earned in a combat zone does 

not count as earned income for purposes of calculating certain refundable credits

• Between 5,000 and 10,000 members in one-earner households likely suffered a net loss of tax benefits by serving in a combat zone in 2003.
Enclosure I 

Page 10 GAO-04-721R Military Compensation

4

Results in Brief, cont.

• It is more difficult to estimate reliably the number of members with working spouses who lost tax benefits; however, we believe that number is not likely to 

be much higher than several thousand and could be less than that.

• The size of the tax benefit loss varies considerably—the maximum is $4,534 or $3,229, for enlisted members and officers, respectively;

• In general, the members losing tax benefits have served in a combat zone longer than 6 months, are in lower pay grades, are married with children, and 

earn little to no investment or spousal income. 

• Conversely, some other low-income members earn larger Earned Income Tax Credits 

than they otherwise would have by serving in a combat zone. Moreover, some members 

with incomes well above the normal cutoff for earned income credit eligibility become 

eligible for it when combat zone service reduces their earned income for tax purposes. 

• Benefits, such as health care and retirement, are a substantial portion of military 

compensation. DOD offers a wide range of benefits to members, including some 

that can assist military members in building wealth.
Enclosure I 

Page 11 GAO-04-721R Military Compensation

5

Regular Military Compensation:

Basic Pay

• Determined by a member’s rank and years of service. See table below for 

excerpts from the fiscal year 2003 pay chart. 

Annual Basic Pay in Dollars

Source: DOD.

Enlisted-3 16,283 17,305 18,346 18,346 18,346 18,346 18,346 18,346 18,346 18,346 18,346 18,346

Enlisted-7 24,822 27,094 28,127 29,138 30,197 32,015 33,041 34,060 35,885 36,796 37,663 38,192

Enlisted-9 - - - - - - 42,772 43,740 44,964 46,404 47,848 50,170

Officer-3 34,934 39,604 42,746 46,602 48,834 51,282 52,870 55,480 56,833 56,833 56,833 56,833

Officer-6 $55,238$60,685$64,667 $64,667 $64,915 $67,694 $68,065 $68,065 $71,935 $78,772 $82,786 86,800

Officer-9 - - - - - - - - - - - $126,763

<2 2 3 4 6 8 10 12 14 16 18 20

Years of service

Pay 

grade
Enclosure I 

Page 12 GAO-04-721R Military Compensation

6

Regular Military Compensation:

Basic Allowance for Housing

Range of annual allowance in dollars

Without dependents With dependents

Enlisted 1-9 4,512 – 29,952 6,012 – 35,352

Warrant officer 1-5 5,940 – 33,000 7,188 – 37,284

Officer 1-10 $5,532 – 35,064 $6,336 – 41,292

Pay 

grade

• All members receive a nontaxable allowance to offset the cost of renting 

civilian housing, unless they live in government-provided housing;

• Members’ allowances depend on location, pay grade, and dependent 

status;

• Allowance accounts for about a quarter of regular military compensation. 

Source: DOD. 

Related GAO product: U.S. General Accounting Office, Military Personnel: Higher Allowances Should Increase Use of 

Civilian Housing, but Not Retention, GAO-01-684 (Washington, D.C.: May 31, 2001).
Enclosure I 

Page 13 GAO-04-721R Military Compensation

7

Regular Military Compensation:

Basic Allowance for Subsistence

• Nontaxable allowance intended to offset the cost of meals for 

members.

• All members receive an allowance for subsistence. 

Enlisted 1-9 2,914

Warrant officer 1-5 2,006

Officer 1-10 $2,006

Annual allowance

in dollars

Pay grade

Source: DOD. 
Enclosure I 

Page 14 GAO-04-721R Military Compensation

8

Special Pays, Incentives, and Other 

Allowances

• There are over 50 special pays, incentives, and allowances; 

• Annual payments can range from a few hundred dollars to $30,000.

Special Pays and Incentives

Examples: 

Flight Deck Duty

Hostile Fire/Imminent Danger

Aviation Career Incentive

Career Enlisted Flyer Incentive

Career Sea

Medical Officers’ Variable Special Pay

Selective Reenlistment Bonus

Other Allowances

Examples: 

Family Separation Allowance*

Uniform Allowance*

Cost of Living Allowance

Overseas Housing Allowance*

Special Position Allowance

Moving Allowance*

Related Product: United States General Accounting Office, Military Personnel: DOD Needs More Effective Controls to 

Better Assess the Progress of the Selective Reenlistment Bonus Program, GAO-04-86 (Washington, DC: Nov. 8, 2003).

*Designates nontaxable allowance. However, any of these pays or allowances earned in a combat zone are generally 

nontaxable.

Source: GAO analysis
Enclosure I 

Page 15 GAO-04-721R Military Compensation

9

Cash Compensation for Notional 

Service Members

$66,010

1,800

64,210

2,306

2,006

11,064

$48,834

Officer-3

-6 years of service

-Ft. Stewart, Georgia

-Spouse and 3 children

-Special pays: Parachute 

Jumping

Special pays 3,000 9,632 0

Regular military compensation 38,464 50,960 130,186

Regular Military Compensation

Tax advantage from the 4,544 2,261 10,958

two allowances2

$41,464

2,914

12,660

$18,346

Enlisted-3

-3 years of service

-Camp Pendleton, California

-Spouse and 1 child

-Special pays: Imminent 

Danger and Family 

Separation Allowance

$60,592

2,914

9,900

$35,885

Enlisted-7

-14 years of service

-Keesler Air Force Base, 

Mississippi

-Spouse and 2 children

-Special pays: Foreign 

Language Proficiency

Selective Reenlistment 

Bonus

Total cash compensation $130,186

Basic subsistence 2,006

allowance

Basic housing allowance 28,140 1

Basic pay $89,082

Officer-6

-22 years of service

-Washington, D.C. 

Compensation -Spouse and 1 child

(Annual Amount in Dollars) 

1 We assume all members live off base in civilian housing; thus, they receive a housing allowance.

2 These values vary significantly depending on spousal income, number of dependents, and other factors. We assumed no spousal income. The tax 

advantage for the enlisted-3 is relatively high because the allowances are not included in earned income for tax purposes, allowing that member to earn a 

larger earned income credit. 

Source: GAO analysis and DOD. 
Enclosure I 

Page 16 GAO-04-721R Military Compensation

10

Federal Tax Benefits Specific to the 

Military

• The principal advantage for all military members is the exclusion of certain pay and allowances—particularly those for housing and subsistence—from 

taxable income. 

• This tax advantage, as DOD considers it, is the additional income military personnel would have to earn in order to receive their current take-home 

pay if their allowances were taxable. 

• The value of such tax advantages varies significantly, depending on the many factors that determine the effective income tax rate of each 

military household.

• In addition, the income that members earn during each month in a combat zone is excluded from earned income for income tax purposes.1

1Members who serve a minimum of 1 day in a combat zone are eligible to receive the combat zone exclusion for the respective month. For officers, the 

combat zone exclusion was limited to $5,958 per month in 2003. Wages earned in a combat zone are subject to social security and Medicare taxes. 
Enclosure I 

Page 17 GAO-04-721R Military Compensation

11

Effects of the Combat Zone 

Exclusion

• Although most service members benefit from the combat zone exclusion, some members are 

actually disadvantaged by it.

• Certain tax credits (principally the Earned Income Tax Credit and the Additional Child Tax Credit) are refundable, meaning that if a taxpayer’s income is low enough, the credits not 

only offset all of that taxpayer’s liability but can also leave him or her with a refund payment 

from the government.

• But a service member who normally would receive one of these payments could actually have it reduced or eliminated due to service in a combat zone:1

• Over certain income ranges a taxpayer’s refundable credits increase as his or her earned income increases.

• Service in a combat zone reduces the amount of earned income that a member reports for tax purposes and, thus, can reduce or eliminate the refunded portion of the 

taxpayer’s credit. 

• We refer to this effect as a net loss of tax benefits because these low-income members 

receive no offsetting advantage from the combat zone exclusion.

• Conversely, some other low-income members (whose incomes fall within the phase-out range of the 

credit) could earn larger earned income credits by serving in a combat zone than they otherwise would 

have.2 Moreover, some members with incomes well above the normal cutoff for earned income credit 

eligibility become eligible for it when combat zone service reduces their earned income for tax purposes. 

1 In general, the members losing tax benefits have served in a combat zone longer than 6 months, are in lower pay grades, are married 

with children, and earn little to no investment or spousal income. 

2 Within that income range a taxpayer’s credit could increases if his or her taxable earned income is reduced by the exclusion.
Enclosure I 

Page 18 GAO-04-721R Military Compensation

12

Percentage of Service Members in One-Earner 

Families Worse Off by Serving in a Combat Zone in 

2003, by Length of Deployment

Source: GAO analysis. 

Note: Our estimates are based on information provided by DOD on the number of households with a spouse not in the labor force, the 

size of military households, military members’ pay, and 2003 deployment rates. They are also based on the assumption that deployed 

personnel in each grade have the same household characteristics as the total population of service members in each grade. 

• A small percentage of 

members deployed for less 

than 7 months suffered 

overall losses of tax 

benefits.

• Roughly 10 percent of these 

enlisted members deployed 

for a full year had a net loss 

of tax benefits.

• Data limitations make these 

estimates imprecise, and we 

cannot make estimates for 

members with working 

spouses.

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

1 2 3 4 5 6 7 8 9 10 11 12

Months in a Combat Zone

Percent of 

Members 

Negatively 

Affected

% of Enlisted % of Officers
Enclosure I 

Page 19 GAO-04-721R Military Compensation

13

Number of Members Who Served in a 

Combat Zone in 2003, by Months Served

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

1 2 3 4 5 6 7 8 9 10 11 12

Months Served in a Combat Zone

Number of 

Members 

• In 2003 most deployed 

service members served less 

than 7 months in a combat 

zone.

• Very few were deployed for a 

full year.

Source: Defense Manpower Data Center, DOD
Enclosure I 

Page 20 GAO-04-721R Military Compensation

14

Some Military Members Serving in a Combat 

Zone Lost Tax Benefits in 2003

• Given that most service members were deployed for well under a full year, 

we estimate that a relatively small number of them were actually worse off--

from a tax standpoint--due to service in a combat zone in 2003. 

• Most likely, between 5,000 and 10,000 members without working 

spouses suffered a net loss of tax benefits in 2003. 

• It is more difficult to make a reliable estimate for members with 

working spouses because we lack data on spouses’ income. Although 

over 20,000 of these members could have lost tax benefits if their 

spouses’ incomes were very low, we expect that only a small 

proportion of them—not likely much more than several thousand—had 

incomes that low.

• If long deployments in combat zones become more common in 2004, more 

members could suffer overall losses of tax benefits.
Enclosure I 

Page 21 GAO-04-721R Military Compensation

15

Potential Loss of Tax Benefits Resulting 

from the Combat Zone Exclusion

Source: GAO analysis. 

Note: Our estimates are based on information provided by DOD on the number of households with a spouse not in the labor force, the size 

of military households, military members’ pay, and 2003 deployment rates. They are also based on the assumption that deployed 

personnel in each grade have the same household characteristics as the total population of service members in each grade. 

$-

$1,000.00

$2,000.00

$3,000.00

$4,000.00

$5,000.00

1 2 3 4 5 6 7 8 9 10 11 12

Months in a combat zone

2003 Affected 

Members Maximum 

Value of Negative 

Tax Effect

Enlisted Officers
Enclosure I 

Page 22 GAO-04-721R Military Compensation

16

Some Service Members Become Eligible to Receive 

the Earned Income Tax Credit from the Combat Zone 

Exclusion

• Many members with incomes exceeding the normal upper limit for the credit could become eligible for the Earned Income Tax Credit if they are in a combat zone for at 

least 6 months. 

• All members who are 25 years or older, have no children, and have less than $81,000 of income have the potential to become eligible for the credit by 

serving long enough in a combat zone. However, the amount of credit these 

members can earn is less than $400.

• Over 75 percent of members who have incomes between $50,000 and $60,000, have children, and have a spouse who is not in the labor force could 

become eligible to receive the earned income tax credit if they have served 

between 6 and 11 months in combat zone. The credit could be as high as 

$2,547 for those with 1 child and $4,204 for those with 2 or more children in 

2003. 

• We cannot reliably estimate the total number of members who become eligible.

Note: Our estimates are based on information provided by DOD on the number of households with a spouse not in the labor force, the 

size of military households, military members’ pay, and 2003 deployment rates. They are also based on the assumption that deployed 

personnel in each grade have the same household characteristics as the total population of service members in each grade. 
Enclosure I 

Page 23 GAO-04-721R Military Compensation

17

DOD Is Aware That Some Members 

May Be Affected

• The Department of Defense (DOD) has started receiving sporadic reports 

from members who are being disadvantaged (or advantaged) by these tax 

provisions. 

• To address this situation, DOD officials told us that they have

• Provided the Treasury with data on active duty and combat zone 

personnel; 

• Suggested changes to the Earned Income Tax Credit rules. 
Enclosure I 

Page 24 GAO-04-721R Military Compensation

18

Benefits

• DOD offers a wide range of 

benefits; such benefits represent 

a large cost to DOD. The 

Congressional Budget Office 

recently estimated that these 

benefits cost about $56,000 per 

active duty member.1

• Many benefits are directed at 

members with family obligations. 

In addition, we found in some 

cases that benefits available to 

military personnel exceed those 

offered by private-sector 

companies.2 DOD believes 

benefits are central to morale 

and readiness. 

Examples:

Active Duty

Benefits

DOD dependent schoo sl

Space-available travel

Paid time

off

Legal assistance

Privileges at military facilities

Disability

Health care

Family support services

Com

missaries and exchanges

Life insurance

Community subsidies

Child & youth programs

Death and burial benefits

Retirement

On-base Housing

Education assistance

1Congressional Budget Office, Military Compensation: Balancing Cash and Noncash Benefits (Washington, D.C.: Jan. 16, 2004). 

2U.S. General Accounting Office, Military Personnel: Active Duty Benefits Reflect Changing Demographics, but Opportunities Exist to Improve, GAO-02-

935 (Washington, D.C.: Sept. 18, 2002). 

Source: GAO analysis.
Enclosure I 

Page 25 GAO-04-721R Military Compensation

19

Wealth-Building Programs Specific 

to the Military 

•Members who remain on active duty for 20 or more years are eligible 

•Members make no contribution to this.

•No vesting is offered prior to 20 years of service—currently DOD estimates 

that 47 percent of officers and about 15 percent of enlisted members will 

reach retirement. 

Military Retirement

•No money down, mortgage-backed loan program is available to service 

members who have served 181 days on regular active duty and have not 

been discharged from a previous qualifying period of active duty. 

Veterans Affairs 

Guaranteed Home Loan

•Members deployed to a combat zone, qualified hazardous duty areas, or 

certain contingency operations can contribute up to $10,000 and earn a 

guaranteed 10 percent interest rate.

•The interest earned is taxable. 

•Across the services, less than 1 percent of members participate.

The Savings Deposit 

Program

•Since 2001, members can contribute a percentage of their basic pay to be 

invested in one or more of the funds offered by the Plan, before taxes.

•Participation rates for active duty military personnel is 21 percent.

Thrift Savings Plan

Program Description

Source: GAO analysis.
Enclosure I 

Page 26 GAO-04-721R Military Compensation

20

General Wealth-Building Tax 

Provisions

• Military members can take advantage of tax provisions available to 

citizens that encourage wealth building, including 

• Individual Retirement Accounts (IRAs);

• Tax credit for elective retirement account contributions;

• Deduction for mortgage interest;

• Deduction for property taxes; and 

• Exclusion of capital gains on principal residence sales.
Enclosure I 

Page 27 GAO-04-721R Military Compensation

21

Matter for Congressional Consideration

• If the Congress wishes to remedy the unintended tax 

consequences associated with the combat zone exclusion, it 

should consider revising the rules of the Earned Income Tax 

Credit and the Additional Child Tax Credit with respect to 

income earned in a combat zone.
Enclosure II 

Page 28 GAO-04-721R Military Compensation

Methodology for Estimating Tax Effects of the Combat Zone Exclusion 

This enclosure describes the data and methodology we used to estimate (1) the extent of net 

loss of tax benefits from the combat zone exclusion and (2) the number of higher-income 

members who become eligible to earn the earned income tax credit as a result of service in a 

combat zone. 

Estimating the Extent of Net Loss of Tax Benefits

The tax effect of the combat exclusion is the difference between what a member’s tax liability 

would have been with no time spent in a combat zone and his or her actual tax liability after 

having spent one or more months in a combat zone. The only conditions under which this tax 

effect can be negative is if (1) the service member’s tax liability would have been negative if he 

or she spent no time in a combat zone and (2) the member’s actual liability was a smaller 

negative value, zero, or positive after service in a combat zone. The first of these conditions is 

met if the member would have been able to earn refundable tax credits that more than offset his 

or her precredit tax liability. The second condition is met if the combat zone exclusion reduces 

the member’s earned income to such an extent that the refunded portion of the member’s tax 

credit is reduced or eliminated.7

 

Due to significant data limitations, we were not able to make a precise estimate of the number 

of service members negatively affected by the combat zone exclusion in 2003. Nevertheless, the 

limited data available from DOD permitted us to estimate the rough order of magnitude of this 

number. The only way to make precise estimates of the two different tax liabilities (both in and 

out of the combat zone) for each member that served in a combat zone in 2003 would be to 

match personnel data from DOD with tax records from IRS for each of those members. We 

could not follow this approach because IRS records for 2003 would not be available to us for 

months. Given the time frames of this report, the only data we were able to use were Defense 

Manpower Data Center’s aggregate numbers of service members in each enlisted and officer 

grade that were deployed in combat zones during 2003 and the limited data that DOD could 

provide us on relevant characteristics of service members, aggregated at the grade level. After 

discussing the reliability of the combat zone data with agency officials, we determined the data 

to be sufficiently reliable for our purposes. 

 

Our overall estimation approach involved two steps. The first step was to compute the two tax 

liabilities for an extensive set of hypothetical service members. These hypothetical 

computations identified every combination of pay level, family size, and length of service in a 

combat zone during 2003 that could have resulted in a negative tax effect. The second step in 

our methodology was to use data on the characteristics of all active military personnel, by pay 

grade, as well as data on the number of service members from each pay grade that were 

deployed in a combat zone during 2003 to estimate the number deployed members who had 

 

7

 The only refundable tax credits that are likely to be widely used by members of the military are the earned income 

tax credit and the additional child tax credit. Over certain income ranges, the amount of credit that a taxpayer 

earns increases with earned income. Income earned in a combat zone is not included as earned income for the 

purpose of computing these credits. Consequently, there are cases where the combat zone exclusion reduces the 

refunded portion of the credits that members would otherwise have earned. 
Enclosure II 

Page 29 GAO-04-721R Military Compensation

income and family characteristics consistent with the hypothetical cases that showed negative 

effects. 

Data from the DOD’s Selected Military Compensation Tables (current as of October 2003) 

allowed us to make reliable estimates of the percent of married service members within each 

pay grade with one, two, three, and four or more children. The data indicated that the number 

of single service members with children in each grade was negligible, and so we excluded this 

subpopulation from our analysis. The same data source enabled us to determine the basic pay 

of service members, by pay grade and years of service. However, we did not have data on three 

other types of taxable income that we needed for our estimates: special pays, investment 

income, and spousal income.8

 In the absence of the special pay and investment income data we 

used ranges of assumptions for the amounts of each of these types of income that each service 

member earned. These ranges of assumptions are reflected in the range that we provide for our 

end results. To deal with the lack of data on spousal income, we separated the service member 

population into two groups—those with spouses in the labor force and those without.9

 The lack 

of data on spousal income does not affect our estimates for members without spouses in the 

labor force. Consequently, we could more easily estimate, at least within a broad range, the 

number of members in that group who were negatively affected by service in the combat zone. 

In contrast, we did not feel that we could reliably specify a range for the number of members 

with working spouses who were negatively affected; however, as we explain below, we were 

able to assess a rough order of magnitude for this group. 

By combining the family and pay grade data listed above, we were able to estimate the number 

of all service members within a particular pay grade and with a specific number of years of 

service who had nonworking spouses and various numbers of children.10 We also had DOD data 

that allowed us to determine what percent of members in each pay grade were deployed in a 

combat zone for one month, what percent were deployed for two months, etc., for all possible 

lengths of stay in a combat zone. By assuming that the distribution of family characteristics 

across the deployed members within a particular pay grade and years-of-service category was 

the same as the distribution across all members (deployed or not) within that same grade and 

category, we were able to estimate the number of members with nonworking spouses who had 

the specific combinations of pay, family characteristics, and months of service in a combat zone 

that would have resulted in a net loss of tax benefits. 

In the case of members with working spouses, we followed an approach similar to that just 

described; however, due to the lack of data on spousal income, there is greater uncertainty 

surrounding each member’s household income and, thus, greater uncertainty about whether the 

member was negatively affected. Through our computations for hypothetical taxpayers, we 

determined that only members in grades E-1 through E-6 with working spouses were likely to 

 

8

 We did not need information on nontaxable allowances because they have no effect on tax liabilities either in or 

out of a combat zone and, therefore, had no effect on our estimates. 

9

 The July 2002 Status of Forces Survey of Active-Duty Members showed the percent of members with spouses not 

in the labor force. This survey percent is provided by broad pay grade groups, rather than for each individual grade 

(e.g., there was a single percent for all members in pay grades E1 to E3). 

10 An important assumption that we made when combining these data is that the work status of a member’s spouse 

was independent of the number of children that the member has. (The available data showed the percent of 

members by aggregated pay grade levels with a spouse not in the labor force and, separately, showed the percents 

of members in each grade with various numbers of children. The data did not show the joint occurrence of a 

nonworking spouse and a specific number of children.) 
Enclosure II 

Page 30 GAO-04-721R Military Compensation

be negatively affected, and the large majority of those would be affected only if their spouses 

earned less than $6,000 in 2003. We estimate that up to about 25,000 members with working 

spouses were in a combat zone for long enough periods in 2003 to have the potential to be 

negatively affected if their spouses’ incomes were sufficiently low. We do not have actual data 

on the number of spouses with income low enough to have a negative effect. However, we 

believe that likely only a small percentage of them actually were negatively affected. 

Estimating the Number of Higher-Income Members Who Become Eligible for the Earned 

Income Tax Credit 

To estimate the number of higher-income members who become eligible for the Earned Income 

Tax Credit, we follow the same general approach described above. However, instead of using 

tax rules and data on income, family size, and lengths of stays in combat zones to identify those 

members whose specific circumstances would result in a negative tax effect, we used the same 

information to identify those members who would not qualify for the Earned Income Tax Credit 

under normal circumstances, but who do qualify when they are deployed for a sufficient length 

of time in a combat zone. 

As was the case with our estimates of the net loss of tax benefits, we cannot make a reliable 

estimate for members with working spouses. Although, we cannot make an estimate for the 

population of members without children, those members can qualify for an Earned Income Tax 

Credit of up to $400, but only if they are over 25 years old. We have no information on the age 

of members deployed in 2003, so we cannot determine how many of these members would 

qualify. 

(350425) 
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