The recently enacted “Heroes Earnings Assistance and Relief Tax Act of 2008” (the 2008 Heroes Act) provides tax relief for military members and their families.   The 2008 Heroes Act renews, expands, and makes permanent several provisions of previous legislation; but also includes many new provisions for tax relief for military personnel and their families.  The Act also has revenue raising provisions to offset the cost of the tax relief to the federal government.

The 2008 Heroes Act makes permanent the ability to include combat pay as earned income for purposes of the earned income tax credit; previously this benefit was only available for tax years ending before 2008.  Also made permanent is the exception that permits qualified mortgage bonds to be issued to finance mortgages for qualified veterans who served in the active military without regard to the first-time homebuyer requirement.  Finally, the expiring Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans has been made permanent.
 

Some of the new provisions of the 2008 Heroes Act include allowing members of the reserves called to active duty to withdraw unused amounts held in flexible spending accounts (health FSAs), modifications to the law which provides certain retirement plan protections for reservists who are called to active duty and who are able to return to their civilian employers after serving our country, and extends the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs disability determinations.  Another provision clarifies that those in the active military who file a joint return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
 

One impact the Act has on small employers is that it allows a 20% tax credit for differential wage payments made to employees who are on active military duty.  Differential wages paid by an employer to an employee who becomes active duty are included in the calculation of wages for retirement plan and IRA purposes.  Also, differential pay is made subject to federal income tax withholding, effective for amounts paid after 2008.
 

Tax relief or tax reduction legislations often have provisions that raise taxes or generate some sort of revenue to offset the loss of tax revenue the relief provides.  Essentially some taxpayers benefit by paying less taxes, while other parties pick up the slack by paying more.
 

The first revenue raising provision of the 2008 Heroes Act increases the minimum penalty for failure to file an individual tax return within 60 days of the due date to the lesser of $135 (up from $100) or 100 percent of the amount of the amount of tax required to be shown on the return, effective for tax returns required to be filed after 2008.  The provision is estimated by the government to raise $296 million over 10 years.
 

The second provision to offset the cost of the new tax breaks treats foreign subsidiaries of US companies performing services under a US government contract as American employers for employment tax purposes.  Under the new law, the domestic parent is jointly liable for employment taxes imposed on the foreign subsidiary.  This provision is estimated to raise $846 million over the next 10 years.
 

The final revenue raising offset of the 2008 Heroes Act is a capital control measure that tightens expatriation rules.  This form of capital control is nothing new, for instance the Reich Flight Tax passed into law in Germany in 1931 was a similar measure.  Under the provision, high net-worth individuals are treated as if they sold all of their property for its fair market value on the day before they terminate their residency.  Gain is recognized to the extent that the aggregate gain recognized exceeds $600,000.  The US government estimates that $411 million over 10 years will be raised by the tightened expatriation rules.
 

Please keep in mind that this is only a summary of some of the tax changes brought about by the 2008 Heroes Act, and that if you would like to discuss any of these provisions in greater detail, please do not hesitate to contact one of our tax professionals.