Tax law is complicated and while many military families file their own taxes, when it’s time for separation from active duty, it’s also time for a tax professional.
Lisa Mayo, a certified public accountant with 17 years of tax experience and 20 years as a military spouse, said she’s noticed a few costly mistakes that service members make in the transition. The biggest one being they fail to plan in the year of retirement.
Here are the tricks for cushioning taxes – or reducing tax liability – for soon-to-be veterans who are exiting the service.
Residency changes and state taxes
While on active duty, a service member is not required to change their state of residency with each move, Mayo said. The same is true for most military spouses. If you enlisted from Texas, you stay a Texas resident – with no state income tax – until you leave the military.
But when you leave the military, you become a resident of the state you are living in and are responsible for state taxes. So, if you were a Texas resident, and now live in New Jersey, you’re going to see a significant difference in your state income tax.
Mayo recommended taking that into consideration when deciding where to live. Along with state income tax rates, you’ll want to keep in mind the state’s tax rate for military retirement. Some don’t tax it, some partially tax it and others tax it at the same rate as all income.
Multiple streams of income
The next thing to review is the multiple streams of income you’ll have when leaving the military.
First, you’ll have your military W-2 income for part of the year. Then you’ll likely have another job with W-2 income, and, if applicable, retirement pay.
The problem with this, Mayo said, is that these jobs don’t talk to each other for tax planning purposes. So, the military withholding for the few months you were on active duty is not going to help the tax liability that increases with your higher-paying, civilian job.
Often, Mayo sees her clients are short on tax withholding that first year — sometimes by $20,000.
“Chances are you’re withholding at about five to 10% less than you should be, especially in that first year,” Mayo said. “And if we can catch it prior to even a year later, it’s usually fixable.”
Tax wishing and tax planning
To avoid a surprise tax liability, some planning is required.
“I call it tax planning up until Dec. 31, and anything after that is tax wishing,” Mayo said. “You wish you had done something different.”
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Planning looks at your withholding based on your total income. It also involves reducing your tax liability by contributing to retirement plans. And it often means talking to a tax professional, and a financial planner, to determine realistic expectations for your tax liability after the military.
How to find a tax accountant to help
An important step is to find a tax accountant that is licensed in your state, fits your personality, does tax planning and – most importantly – understands military tax law.
Mayo suggested looking at the CPA Verify website, state CPA society lists or the National Association of State Boards of Accountancy website to find some options for tax planners.
“While you can’t start planning until the year of retirement, you can find a CPA and financial advisor beforehand to start looking at all options,” Mayo said.
This article was originally published in the 2022 Veterans Financial Readiness Toolkit.
