How to Make the MSRRA Work for You This Tax Season

How to Make the MSRRA Work for You This Tax Season

A new year means it’s time to pay taxes for the previous one. Do you dutifully view the annual exercise as your contribution toward the cost of running the government? Or do you rank taxes right up there with going to the dentist? Whether your outlook is agreeable or leans toward disgruntled, paying taxes is an unavoidable obligation and we all want them to be as low as possible. That’s why it’s important to be knowledgeable about policies that can lower your tax bill. If you are married to a service member, the Military Spouse Residency Relief Act (MSRRA) is legislation that may allow you to avoid paying state income taxes and give your family a financial break.

What is MSRRA?

MSRRA is a 2009 amendment to the Servicemember’s Civil Relief Act (SCRA) that aligns state income tax rules for military spouses with the rules for service members. Previously, a service member filed state income taxes in his or her state of legal residency despite being stationed elsewhere under military orders, yet the spouse had to file in the state where he or she was working while living with the service member. With MSRRA, military spouses can also file state income taxes in the couple’s state of legal residency rather than the state where income is earned. It provides much-needed relief from the complexities that arise for military families who move frequently by allowing both income earners to pay taxes in the same state. Since state tax policies vary, making a strategic decision about your state of legal residency – particularly one with no income tax – can put your family in a better position at tax time.

What criteria must be met to qualify under MSRRA?

For a military spouse to pay income taxes in their state of legal residency rather than the state in which they are presently living on military orders and earning income, the following circumstances must exist:

• A service member is living on military orders in a state that is not his or her legal residence.
• The military spouse is in that state to live with the service member.
• Both the service member and the spouse have the same state of legal residency.

Understanding legal residency

For most Americans, legal residency is straightforward – it is where they live. But it can be complicated for military families who transfer from one state to another every few years for PCS moves. Legal residency, sometimes called a domicile, is where one physically lives on a permanent basis or will return to after a temporary absence for circumstances like military orders.

Establishing or proving legal residency entails more than just a physical address and your personal declaration. It is a process that requires actions like holding a driver’s license, registering to vote, owning property, registering vehicles, holding professional licenses, or establishing estate plans. Establishing legal residency also includes your intention to abandon your former state of legal residency.

Laws differ between states and there is no one combination of actions that will secure legal residency, so check the requirements for the state where you wish to establish residency. For added assurance, contact a legal or tax professional who can assess and assist with your particular circumstances.

Navigating the Military Spouse Residency Relief Act

What are some likely scenarios in which MSRRA might affect your taxes? Prior to MSRRA, if a service member with legal residency in a state with no state income tax transferred to a state with a state income tax, his or her working military spouse had to pay income tax in the new state. Now, under MSRRA, the military spouse’s state income taxes are based on the couple’s state of legal residency, so the spouse does not have to pay state income tax where the couple is stationed.

In the reverse scenario, if a state income tax is assessed in a couple’s state of legal residency but not in a state in which they are stationed on military orders, the service member and the working military spouse will pay income taxes to their state of legal residence, even if the income is earned elsewhere.

In the event a service member and working military spouse with legal residency in a state with no income tax are stationed in a state with an income tax, but then the service member is transferred out of state on orders and the military spouse chooses to stay in the state with an income tax, the spouse now has to pay income tax there. A military spouse must live in a state where the service member is currently on orders to qualify for MRSSA and continue paying taxes in their state of legal residency.

Put MSRRA to Work for Your Taxes

A military transfer to a state with no income tax presents an interesting opportunity for a shift in legal residency that can be advantageous for your taxes. If your state of legal residency has a state income tax and you will be living in a state with no income tax for several years on military orders, it might be worth working to establish residency there. It gives you the chance to reduce your state income taxes, not just while stationed there, but for as long as you remain an active-duty military family and maintain your legal residency in that state. So if your family is transferred later to a state with an income tax, under the protections of MSRRA you can continue to file your state taxes where you’ve established legal residency.

Applied strategically, MSRRA can help your family save money, but it requires some forethought. Changing your legal residency takes time, so begin looking into your options soon after transferring to a new state. It’s not something you can realistically undertake right before your taxes are due.

And even with time on your side, shifting your legal residency shouldn’t be done solely because your spouse’s military career transfers your family to a state with no income tax. It takes time and effort to establish residency so be sure it is advantageous for you to do so. As is often the case, tradeoffs can be involved, so be sure giving up legal residency in your previous state is in your family’s best interest. It’s important to look at a state’s complete tax picture, not just the lack of a state income tax. Yes, it’s appealing when a state doesn’t have an income tax, but you should also look at property taxes, city and county taxes, and sales tax. And factors like where you may want to have residency status to secure in-state college tuition for your children may be an eventual consideration.

Additionally, keep in mind that when you separate or retire from the military, your state of legal residency may not be where your family will choose to put down civilian roots, which might require working through the residency process once again. All in all, make sure your residency decisions are right for your family in both the short and long term for tax and non-tax purposes. Examine your overall financial circumstances and work with a knowledgeable professional who can help you assess your options.

MSRRA and your taxes are just part of your complete financial picture, so look for more ways to help your military family win at tax time. And if you’re ready to put all the pieces together and start working toward your financial goals, get started with a First Command Financial Advisor today.

MSRRA FAQ:

Q: Is legal residency the same as your home of record?

A: No. A home of record is the place where a service member entered the military, not necessarily where one is from, where one lives, or where one established legal residency.

Q: Can I choose what state I want for my legal residency?

A: Legal residency is established, not simply chosen based on personal preference. It requires actions like getting a driver’s license, voting or owning property, along with giving up residency in a state where you previously held it. If you are stationed on military orders in a state where you wish to establish legal residency, you can certainly undertake the actions needed to meet that state’s criteria. Rules vary from one state to another so be sure to understand the requirements where you are pursuing legal residency.

Q: If my active-duty spouse is transferred on orders to another state, but I want to stay where we are currently living – perhaps to keep my job or to keep our kids in their school – will we still qualify for MSRRA?

A: Both spouses must live together in a state where the service member is currently on orders to qualify for MSRRA.

Q: Do all forms of income qualify under MSRRA?

A: MSRRA applies to wages or income earned on employment services that are performed in a non-domicile state. Other income, like income on the sale of property or rental income, is taxable in the state where the property is located. Rules for self-employment income vary from state to state.

Q: What documentation do I need to prove legal residency and qualify for MSRRA?

A: Requirements vary but likely documents for a military spouse include a military dependent identification card, proof of a military member’s state of legal residence on a Leave and Earnings Statement (LES), a current driver's license from the state of residence, a marriage certificate, military orders, or DD Form 2058 - State of Legal Residence Certificate. 

Q: What are the states with no income tax where I can take advantage of MSRRA?

A: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming do not tax wage income. New Hampshire does tax dividend and interest income and Washington taxes capital gains income. Policies vary by state, so it’s important to consider the complete picture, not just state income taxes. Learn more about MSRRA and see how it applies to your circumstances by checking specific details for your state.

First Command does not provide legal or tax advice, and this article does not contain any legal or tax advice. Should you require legal or tax advice specific to your situation, you should consult with an attorney or qualified tax advisor. The information provided to you herein is provided for informational purposes only, is not intended to be tax or legal advice, and should not be used for the purpose of avoiding tax-related penalties under the Internal Revenue Code.