J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

35.4 Tax-Free Pay for Service in Combat Zone

If your grade is below commissioned officer and you serve in a designated combat zone during any part of a month, all of your qualifying military pay (see below) for that month is excluded from your taxable income. You may also exclude military pay earned during any part of a month that you are hospitalized as a result of wounds, disease, or injury incurred in a combat zone. The exclusion for military pay while hospitalized does not apply to any month that begins more than two years after the end of combat activities in that combat zone. Your hospitalization does not have to be in the combat zone.

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Filing Tip

Who Qualifies for Exclusion?

Members of the U.S. Armed Forces qualifying for the exclusion include commissioned officers and enlisted personnel in all regular and reserve units under control of the Secretaries of Defense, Army, Navy, and Air Force, and the Coast Guard. Members of the U.S. Merchant Marines or the American Red Cross are not included.

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Officers.

If you are a commissioned officer, you may exclude up to the highest rate of basic pay at the highest pay grade that enlisted personnel receive per month plus any hostile fire/imminent danger pay received for each month during any part of which you served in a combat zone or were hospitalized as a result of the combat zone service. ...