Nontaxable military pay
Nontaxable pay for members of the Armed Forces is not considered earned income for the Earned Income Tax Credit or EITC. Examples of nontaxable military pay are combat pay, the Basic Allowance for Housing (BAH), and the Basic Allowance for Subsistence (BAS). See the special rules for Combat Pay and EITC below.
Combat Pay and EITC
You can elect to include your nontaxable combat pay in earned income for EITC. If you are filing a joint return and both you and your spouse received nontaxable combat pay, you can each make your own election. You and your spouse can each choose to have all of your nontaxable combat pay included in earned income or none. That is, you can choose to include all your nontaxable combat pay and your spouse can choose zero, or you can both choose to include all or you can both choose none. But, if you (and/or your spouse) make the election, you must include in earned income all nontaxable combat pay you received. You can’t choose to include only a part of the nontaxable combat pay in earned income. Find more examples in Publication 596 under Nontaxable Combat Pay.
Electing to include nontaxable combat pay in earned income may increase or decrease your EITC. Calculate your taxes both ways to find out what’s best for you. The amount of your nontaxable combat pay is on your Form W-2, in box 12, with code Q.