Combat Zone Tax Exclusion and the Foreign Earned Income Exclusion

If you work in a combat zone, you can exclude a hefty portion of your salary or compensation either through the Combat Zone Exclusion or through the Foreign Earned Income Exclusion.  

What Is the Combat Zone Exclusion? 

The combat zone exclusion applies to wages and compensation paid by the US government to military and civilian employees. To qualify, employees must be serving in a designated combat zone or hospitalized as a result of serving in a combat zone.  

What Is the Foreign Earned Income Exclusion? 

The Foreign Earned Income Exclusion (FEIE) applies to defense contractors and employees of contractors (as well as other expats). The Foreign Earned Income Exclusion allows you to exempt a portion of the compensation you earn while residing outside of the United States. The first $108,700 of foreign compensation earned in the year 2021 can be exempt from income tax in the US. Any wages and self-employment income above this amount is taxable. This foreign earned income exclusion helps keep your total taxable income considerably lower, often resulting in little or no US taxes. To qualify, the contractor needs to be supporting the US armed forces in a designated combat zone. Additionally, they need to live outside the US long enough to meet either the physical presence test or the bona fide residence test. 

What If I Am Unsure If I Am in a Combat Zone? 

If you are unsure about whether or not you’re in a combat zone, here is a full list of active combat areas, support areas, and qualified hazardous duty areas that qualify for the combat zone tax breaks:  

• Adriatic Sea 
• Afghanistan 
• Albania 
• Arabian Peninsula 
• Arabian Sea (the part that’s north of 10 degrees north latitude and west of 68 degrees east longitude) 
• Bahrain 
• Djibouti 
• Federal Republic of Yugoslavia (Serbia/Montenegro) 
• Gulf of Aden 
• Gulf of Oman 
• Iraq 
• Jordan 
• Kosovo 
• Kuwait 
• Kyrgyzstan  
• Ionian Sea 
• Oman 
• Pakistan 
• Persian Gulf 
• Philippines 
• Qatar 
• Saudi Arabia 
• Sinai Peninsula 
• Somalia 
• Syria 
• Tajikistan 
• United Arab Emirates 
• Uzbekistan 
• Yemen 

Combat Zone Tax Exclusion for Contractors: How Do I Capitalize on These Tax Breaks?  

For military and civilian personnel of the US government, the amount of income that can be excluded from tax is already shown on Form W-2. The amount of wages shown in box one does not include any combat pay. In other words, the combat zone exclusion has already been factored into the income reported to the IRS. There are no special forms to fill out regarding the combat zone.  

Defense contractors and employees of defense contractors, however, will need to claim their foreign earned income exclusion on Form 2555. This form calculates the amount of the exclusion for which a person is eligible. This form is filed along with the rest of the tax return for the year, as the Combat Zone Tax exclusion for contractors. 

Combat Zone Tax Exclusion for Civilians: Can I Also Exclude My Foreign Assets and Investments? 

No. US citizens may be required to disclose any bank accounts, investments, and other types of financial assets held at foreign banks and financial institutions for the Combat Zone Tax exclusion. The Foreign Bank Account Report (FBAR), for example, is required if a US person has a combined balance of at least $10,000 at any time during the year across all their foreign accounts. This also applies to Combat Zone Tax Exclusion for civilians and contractors

Greenback Is Proud to Help Our Troops, Civilians, and Contractors Serving in Harm’s Way to Use the Foreign Earned Income Exclusion and Combat Zone Exclusion!

We can help you claim the Foreign Earned Income Exclusion or Combat Tax Exclusion on compensation earned as a contractor. We also make sure we disclose your foreign assets and investments accurately, so you are fully compliant with IRS requirements. Get started with one of Greenback’s expert accountants today, and learn more about combat zones.