Knowledge Center Tax Advice for Specific Needs

Do Military Contractors Pay U.S. Taxes While Working Overseas?

According to the Defense Contract Management Agency, over 50,000 U.S. defense contractors work overseas supporting American military operations. If you’re a contractor stationed abroad, here’s the relief: most military contractors earning under $130,000 owe $0 in federal income tax. A 2018 law change specifically helped contractors in combat zones qualify for the Foreign Earned Income Exclusion, making it far easier to eliminate your tax bill entirely.

You still must file a tax return annually, but between the Foreign Earned Income Exclusion, housing deductions, and other expat benefits, the vast majority of contractors pay nothing in federal income tax. This guide covers the contractor-specific tax rules you need to know.

Do I Have to File U.S. Taxes as a Military Contractor?

Yes. Military contractors must file U.S. tax returns annually, regardless of location or income level. The IRS treats contractors as civilians, not military personnel, which affects your available tax benefits.

Most contractors working overseas qualify for benefits that reduce their U.S. tax bill to $0. However, failing to file triggers penalties even if you owe nothing.

Key Filing Details:

Automatic extension to June 16, 2026 for those abroad (no form required)
Can extend further to October 15 with Form 4868
Applies to both W-2 employees and independent contractors

Starting Or Renewing An Overseas Contract? Set Up Your Tax Strategy Now.

Tell us about your new assignment, contract rate, and home state. We will map out how FEIE, housing benefits, and state rules apply so your first paycheck and withholdings are set up correctly from day one.

Can I Use the Combat Zone Exclusion?

No. The Combat Zone Exclusion is exclusively for enlisted military personnel. This benefit allows active-duty service members to exclude all income earned during months they served in designated combat zones.

Why Contractors Don’t Qualify:

The Internal Revenue Code limits this exclusion to members of the U.S. Armed Forces on active duty. Civilian contractors, even those working in identical locations doing similar work, cannot use it.

The Better News for Contractors:

The Foreign Earned Income Exclusion typically provides equal or better tax benefits. For 2025, you can exclude up to $130,000 of foreign earned income from U.S. taxation. Since most contractor salaries fall within this range, you’ll likely pay $0 in federal income tax.

Example:
James works as a security contractor in Afghanistan earning $125,000. He cannot use the Combat Zone Exclusion because he’s a civilian. However, using the Foreign Earned Income Exclusion, he excludes his entire $125,000 salary and owes $0 in federal tax.

The 2018 Game-Changer for Combat Zone Contractors

Prior to 2018, most military contractors couldn’t qualify for the Foreign Earned Income Exclusion even when they met the residency requirements. The problem was the “tax home” rule. To claim the exclusion, your tax home had to be in a foreign country, but most contractors maintained their tax home in the U.S. through home ownership, family ties, or state residency.

What Changed in 2018:

Congress waived the tax home requirement specifically for contractors supporting U.S. military operations in designated combat zones. Now you can:

Own a home in the U.S.
Keep your family stateside
Maintain a U.S. driver’s license and voter registration
Still qualify for the Foreign Earned Income Exclusion

Where This Applies:

This waiver applies to IRS-designated combat zones including Iraq, Afghanistan, Syria, Yemen, and Somalia. Check the current combat zones list to verify.

Important

If you work in non-combat locations (Germany, Japan, South Korea), you still need to establish a foreign tax home.

You must still meet either the Physical Presence Test (330 days abroad in any 12-month period) or Bona Fide Residence Test. Learn the details in our Foreign Earned Income Exclusion guide.

What If I Earn More Than $130,000?

You have two options to handle income above the exclusion limit:

Option 1: Combine FEIE with Foreign Tax Credit

If you pay taxes to a foreign government, claim the Foreign Tax Credit for a dollar-for-dollar reduction on income above $130,000.

Example:
David earns $160,000 in Afghanistan and pays $5,000 in Afghan taxes. He excludes the first $130,000 using FEIE, then claims a $5,000 Foreign Tax Credit on the remaining $30,000. After his standard deduction, he owes minimal or no U.S. tax.

Option 2: Housing Exclusion or Deduction

You may also qualify for the Foreign Housing Exclusion (if you’re a W-2 employee) or Foreign Housing Deduction (if you’re self-employed). This allows you to exclude or deduct qualifying housing expenses above $20,800 for 2025.

Qualified expenses include rent, utilities, insurance, and occupancy taxes. This benefit stacks on top of the Foreign Earned Income Exclusion, further reducing your taxable income.

The Self-Employment Tax Trap

If you work as an independent contractor receiving 1099 income, pay close attention: the Foreign Earned Income Exclusion eliminates income tax but does NOT reduce self-employment tax.

What This Means:

Self-employed contractors owe 15.3% in Social Security and Medicare taxes on net earnings, regardless of the Foreign Earned Income Exclusion.

Example:
Marcus earns $120,000 as a self-employed contractor in Iraq:

Foreign Earned Income Exclusion: $120,000 (excludes entire salary from income tax)
Federal income tax owed: $0
Self-employment tax owed: ~$16,956 (15.3% on $120,000)

The Difference for W-2 Employees:

If you’re a W-2 employee of a military contractor company, your employer pays half of your Social Security and Medicare taxes (7.65%), and you pay the other half (7.65%) through payroll withholding. Your total burden is the same 15.3%, but it’s split with your employer.

Totalization Agreements:

Some countries have Social Security agreements with the U.S. (called totalization agreements) that prevent double Social Security taxation. If you work in a country with such an agreement, you may only need to pay into one country’s system. Check if your country qualifies.

Learn more about self-employment tax for expats.

Do I Owe State Taxes?

State tax obligations vary by your state of residence before moving overseas. Unlike military personnel, contractors follow standard civilian rules.

States with No Income Tax:
Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming

Most States:
Don’t tax income earned as a non-resident abroad if you left for an assignment longer than one year.

Aggressive States:
California, Virginia, New York, Massachusetts, and South Carolina often continue taxing contractors who maintain ties like:

Property ownership
Family residence
Driver’s license or voter registration
Bank accounts or stated return intent

California is particularly aggressive. If you own property or maintain significant ties there, expect continued taxation despite overseas work.

To Break State Residency:

Sell your home (or convert to rental business), move family elsewhere, update licenses and registration to another state, and document everything.

Learn more about state taxation for expats.

What If I Haven’t Filed in Previous Years?

Many contractors don’t realize they must file U.S. returns while working overseas. If you’re behind, the IRS Streamlined Filing Compliance Procedures allow you to catch up with no penalties.

You Qualify If:

Your failure to file was non-willful (unintentional)
You lived outside the U.S. for 330+ days in one of the last three years
You file the last three years of returns and six years of FBARs

With the Foreign Earned Income Exclusion, most contractors owe $0 for each year, meaning you’ll file returns showing zero tax with zero penalties.

Learn more about Streamlined Filing Procedures.

Additional Reporting Requirements

Beyond your income tax return, you may need to file:

FBAR (Foreign Bank Account Report):

Required if foreign accounts exceeded $10,000 aggregate value at any time during the year. Due April 15 (automatic extension to October 15). Non-filing penalties start at $16,536 per year. Learn more about FBAR.

FATCA (Form 8938):

Required if foreign assets exceed $200,000 (single) or $400,000 (married) on the last day of the year. Learn more about FATCA.

How Greenback Helps Military Contractors

Greenback’s accountants specialize in military contractor situations and understand the 2018 law change, state tax complexities, and how to maximize your exclusions.

Our Track Record:

23,000+ expats helped, 71,000+ returns filed
4.9-star rating across 1,200+ reviews
Transparent flat-fee pricing
Make It Right guarantee

Most contractor clients owe $0 in federal tax and many receive refunds of withheld taxes.

No matter how late, messy, or complex your return may be, we can help. Contact our Customer Champions with questions or click below to get started.

One Team For Federal, State, And Overseas Contractor Taxes.

Complete a short form once. We will match you with a Greenback accountant who is experienced with military contractors, reviews your federal and state position, and keeps you compliant year after year no matter where you deploy.

This article provides general information about U.S. tax obligations for military contractors working overseas. It is not intended as tax advice for your specific situation. Tax laws change frequently, and individual circumstances vary. The 2018 waiver of the tax home requirement applies specifically to contractors supporting U.S. military in designated combat zones. For personalized advice based on your employment situation and location, consult with a qualified expat tax professional.

Free Guide 15 Tax Tips Every American Expat Needs To Know in 2025

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