What Does the Update to the Military Spouse Residency Relief Act Mean?
On December 31st, the Veterans Benefits and Transition Act of 2018 went into effect. Among other things, it changes how the Military Spouses Residency Relief Act (MSRRA) works and who is eligible to take advantage of it. As with any big government bill, this brings good news and bad news. Good news: all military spouses are now eligible for the MSRRA, and the tax benefits can be applied to the 2018 tax year when you file next month. Bad news: it's going to make your 2018 filing very messy, and residency claims will probably be under additional scrutiny in the future. Let's dig into what all that means.
What changed for the MSRRA in 2018?
The MSRRA was originally intended to simplify tax filing for military families by enabling service members and their spouses to file state taxes together, despite the way military life complicates the question of residency. Unfortunately, it didn't "simplify" anything, and it only applied to service members and spouses who were able to live together. Couples living apart were just out of luck. The new rules make it possible for all military families to take advantage, regardless of their living arrangements. Spouses can now simply elect to adopt the service member's state residency as their own for the purposes of taxation and voter registration. You don't have to establish a physical presence in that state or intend to remain there permanently. So if your service member is a legal resident of a state with low (or no!) income tax, you may be able to file there and save a lot of money.
What this does NOT mean
This does NOT mean you can choose ANY state to file in. If the service member is a legal resident of New York and the spouse is a legal resident of California, they can't just choose to file in Texas because it would mean less taxes. The service member must have an established and legitimate claim to residency. You can choose to keep your current residency, or you can choose to adopt your service member's residency. Those are your options under the new rules. This does NOT mean you can skip filing a return in your current state, even if you choose to switch. In fact, it's the only way to get your previous state withholdings returned to you. This does NOT mean you can skip paying state taxes on money earned overseas. You still owe taxes to your state of residency, whatever you decide.
Ok, I want to adopt my service member's state – what's next?
Step 1: Get expert advice on the specifics and next steps. You should never ever trust the internet to teach you about tax code. In fact, if you're trying to adopt your service member's state for the 2018 tax year, a lot of civilian experts are also going to be clueless. If you typically use tax preparation software, it will be out of date for MRSSA filers. These changes are simply too new for civilian sources to have caught up. Your best bet is to seek counsel from your military installation's legal assistance office and prepare your taxes with the Volunteer Income Tax Assistance program (VITA). They'll be the most prepared to guide you through these unique circumstances. The timing of this legislation – taking effect just four months before the filing deadline – means a lot is still up in the air, including how states are going to respond to the new rules. It's possible that anything you file for the 2018 tax year will get disputed or have to be amended later on. If the discrepancy between tax rates is small, you may want to keep your current residency for 2018 filing purposes and plan to make the change next year, once policies are more established. Step 2: File returns in BOTH states. If you're moving forward for 2018, you need to file state tax returns for both your current state of residency and your new state of residency. For most people, filing in the state where your taxes are withheld will trigger the refund of all your withholdings. The filing in your new state will end with you paying what should have been withheld, unless it's one of the nine lucky states with no income tax. Bear in mind that there's no guarantee you'll get your previous state's withholdings back before you have to pay taxes to your new state. You should anticipate a period of time where you're out the money for both states' taxes. (Ouch). Step 3: Make sure your service member's residency can't be questioned. The rule change means a lot of states with higher income taxes are bound to lose revenue, so it's very likely those states will challenge the residency change for anyone whose circumstances are muddied with lazy paperwork. Make sure your service member's paperwork is all filed in their state of residency. This includes tax returns, voter registration, driver's license, and vehicle title and registration. You don't want to leave any ambiguity they can use against you. The one thing you may not have to worry about is a physical address in your new state. Service members can maintain a legal residency without a valid address as long as they haven't established domicile in a new state. If this applies to you, be sure you have DD Form 2058 (State of Legal Residence Certificate) ready to go, because you may be required to produce it. No one is sure how quickly states will respond with their own requirements to comply with this law, so you'll also want to keep an eye out for a later release of additional steps you'll need to take. Step 4: Work with your payroll department for future withholdings. To minimize the logistical challenges for filing in 2019 and beyond, you'll want to talk with HR or Payroll about changing your state withholdings. Standard employment paperwork assumes that your physical address is an accurate reflection of the state where you intend to file. You'll need to work with your employer directly to ensure all requirements are met and that your withholdings are going to the correct state. Overall, the changes to the MSRRA will be a boon for military families, but in the short term, they'll make for a bumpy ride to the 2018 filing. Now that you have a general overview of what these changes might mean for you, reach out to VITA and your legal assistance office to make sure you get the tax savings you deserve!