Combat Zone Tax Exclusion (CZTE): Maximizing Your Tax-Free Income

Category: Deployment Finance
Last Updated: 2025-01-25
Effective: 2025
Sources: IRS Combat Zones, DFAS Tax Info, IRS Publication 3

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BLUF (Bottom Line Up Front)

If you're deployed to a designated combat zone, your entire base pay is tax-free for every month you spend there - no federal income tax, no state income tax (in most states). For an E-5 earning $3,500/month, that's ~$600/month in tax savings (~$7,200/year on a 12-month deployment). Officers have a cap ($9,801.90/month for 2025), but enlisted have NO CAP - every dollar of base pay is tax-free.

This is the single biggest "raise" you'll get in your military career - use it strategically.

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What is CZTE?

The Combat Zone Tax Exclusion (CZTE) allows service members serving in designated combat zones to exclude their base pay from federal taxable income. This means:

• No federal income tax on base pay
• No state income tax on base pay (in 44 states that follow federal rules)
• TSP contributions from combat zone pay are tax-free (if Roth)
• SDP (Savings Deposit Program) returns on combat zone savings are tax-free

Who Qualifies?

You must be:

• Serving in a designated combat zone (IRS-defined)
• On active duty
• Receiving hostile fire pay (HFP) or imminent danger pay (IDP)

Common Qualifying Locations (2025):

• Iraq, Afghanistan, Syria
• Arabian Peninsula (Kuwait, Saudi Arabia, Qatar, Bahrain, UAE, Oman, Jordan)
• Sinai Peninsula (Egypt)
• Djibouti (Africa)
• Yemen, Somalia

Check your LES: If you see "HFP" or "IDP" pay, you qualify for CZTE.

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How Much Tax Are You Saving?

Enlisted: Unlimited Tax-Free Base Pay

No cap for E-1 through E-9. Every dollar of base pay earned in a combat zone is tax-free.

Example: E-5 with 6 Years, 12-Month Deployment

• Base pay: $3,500/month × 12 months = $42,000
• Federal tax bracket: 22%
• Federal tax savings: ~$9,240
• State tax (if applicable): ~3-5% = ~$1,260-$2,100
• Total tax savings: ~$10,500-$11,340

Bottom line: You keep an extra $875-$945/month just from not paying taxes.

Officers: Cap at $9,801.90/Month (2025)

Officers (O-1 and above) have a monthly cap on CZTE. Any base pay above $9,801.90/month is taxable.

Example: O-4 with 12 Years, 12-Month Deployment

• Base pay: $8,200/month (below cap)
• All $8,200/month is tax-free (no cap issue)
• Annual tax savings: ~$18,000-$20,000

Example: O-6 with 20 Years, 12-Month Deployment

• Base pay: $12,500/month (above cap)
• Tax-free: $9,801.90/month
• Taxable: $2,698.10/month
• Tax savings: ~$26,000 (still massive)

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What's Included in CZTE?

✅ Tax-Free (Combat Zone Pay):

• Base pay (entire amount for enlisted, capped for officers)
• Hostile Fire Pay (HFP) ($225/month)
• Imminent Danger Pay (IDP) ($7.50/day or $225/month)
• Hardship Duty Pay (HDP) (varies, up to $150/month)
• Reenlistment bonuses (if signed in combat zone)
• Assignment incentive pay (if deployed)

❌ NOT Tax-Free (Always Taxable):

• BAH (Basic Allowance for Housing) - Always taxable, even during deployment
• BAS (Basic Allowance for Subsistence) - Always taxable
• Family Separation Allowance (FSA) - Taxable
• Per diem - Taxable
• Special pays not tied to combat zone - Taxable

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Strategic CZTE Moves to Maximize Savings

Strategy 1: Max TSP Contributions During Deployment

Why: TSP contributions from combat zone pay are tax-exempt going in AND tax-exempt coming out (if Roth).

Normal TSP:

• You contribute $1,000 to Roth TSP from taxable income
• Cost: $1,000 + ~$220 in taxes = $1,220 out of pocket
• Retirement: Withdraw $5,000 tax-free (after growth)

Combat Zone TSP:

• You contribute $1,000 to Roth TSP from combat zone pay
• Cost: $1,000 out of pocket (no taxes!)
• Retirement: Withdraw $5,000 tax-free (after growth)

Savings: $220 per $1,000 contributed (22% tax bracket)

Action Plan:

• Increase TSP contribution to 50-75% during deployment
• You're living on base, expenses are minimal, BAH keeps flowing to family
• Max annual contribution: $23,500 (2025) or $30,500 if over 50

Example: E-6 Deployed for 12 Months

• Normal TSP: 10% ($400/month) = $4,800/year
• Deployment TSP: 50% ($2,000/month) = $24,000/year
• Extra $19,200 invested during deployment
• Tax savings: ~$4,224 (22% bracket)
• Future value (30 years at 9%): ~$254,000

Strategy 2: Combine CZTE + SDP for Double Tax Benefit

Why: SDP returns on combat zone savings are also tax-free.

Normal Investment:

• Invest $10,000 in taxable account
• Earn $1,000 return (10%)
• Pay ~$220 tax on gains (22% bracket)
• Net gain: $780

Combat Zone SDP:

• Deposit $10,000 in SDP (from combat zone pay)
• Earn $1,291 return (10% compounded over 12 months + 90 days)
• Pay $0 tax
• Net gain: $1,291

Action Plan:

1. Max SDP first ($10,000)
2. Then max TSP ($23,500)
3. If you still have income left, save for emergency fund

Strategy 3: Time Your Reenlistment Bonus

Why: Reenlistment bonuses signed in a combat zone are tax-free.

Scenario:

• Reenlistment bonus: $30,000
• Signed CONUS: Pay ~$6,600 in taxes (22% bracket) = Net $23,400
• Signed in combat zone: Pay $0 taxes = Net $30,000

Action Plan:

• If your reenlistment window opens before/during deployment, wait to sign in the combat zone
• Timing = $6,600 saved

Caveat: Don't delay if you risk missing your window. Check with retention NCO.

Strategy 4: Extend Your Deployment (If Safe & Worth It)

Why: Every additional month in a combat zone = more tax-free income.

Math:

• E-5 base pay: $3,500/month
• Tax savings: ~$770/month (22% bracket)
• Extra 3 months deployed = $2,310 more in your pocket

Considerations:

• Family separation toll (money isn't everything)
• Mission/unit needs
• Deployment fatigue
• Safety

Bottom line: If you're comfortable and the mission is stable, an extra 90 days can fund a nice post-deployment vacation.

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State Tax Treatment

States That Follow Federal CZTE (No State Tax on Combat Pay):

44 states + DC automatically follow federal rules:

• Alabama, Arizona, Arkansas, Colorado, Connecticut, Delaware, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, South Dakota, Tennessee, Utah, Vermont, West Virginia, Wisconsin, Wyoming, Washington DC

States with Special Rules:

California:

• Does NOT automatically follow federal CZTE
• Combat zone pay IS tax-free, BUT you must file form FTB 3913
• Don't skip this form or you'll pay CA state tax unnecessarily

Virginia:

• Follows federal rules PLUS offers additional $15,000 subtraction for military pay
• Very military-friendly

Pennsylvania:

• Does NOT tax combat zone pay, but has complex rules
• File PA Schedule SP

States with No Income Tax (You're Already Winning):

• Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming

If you're a TX/FL/WA resident: Congrats, you're already maximizing tax savings.

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How CZTE Works on Your LES

What You'll See:

Month 1 (Pre-Deployment):

Base Pay:     $3,500.00
FITW (Fed):   -$385.00 (11% bracket)
State Tax:    -$105.00 (3%)
Net:          $3,010.00

Month 2 (In Combat Zone):

Base Pay:     $3,500.00
HFP:          +$225.00
CZTE:         ($3,725.00)  ← Tax-exempt amount shown
FITW (Fed):   $0.00
State Tax:    $0.00
Net:          $3,725.00

Difference: $715/month more in your pocket

LES Codes:

• CZTE: Combat Zone Tax Exclusion (shows amount excluded)
• HFP: Hostile Fire Pay ($225/month)
• IDP: Imminent Danger Pay ($225/month)
• FITW: Federal Income Tax Withheld ($0 during deployment)

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Filing Taxes After Deployment

Do You Still Need to File?

YES. Even though your combat pay is tax-free, you still must file a tax return if:

• You earned non-combat income (pre/post deployment months)
• You had BAH/BAS/FSA (always taxable)
• You want to claim refunds or credits

What to Report:

Box 1 (Wages) on W-2:

• Shows total income MINUS combat zone pay
• If you deployed all year, Box 1 might show $0 or very low amount

Box 12 (Code Q):

• Shows total non-taxable combat pay
• This is for your records, not added to taxable income

Example W-2 (E-5 Deployed All Year):

Box 1 (Taxable wages):  $15,000 (BAH only)
Box 12 Code Q:          $42,000 (Combat zone base pay)

Common Mistake:

❌ Forgetting to file because Box 1 is low

Even if your taxable income is minimal, file to:

• Claim refunds (if you had withholding before deployment)
• Claim Earned Income Tax Credit (EITC) if eligible
• Avoid IRS notices

Using Military Tax Software:

Free options:

• MilTax (free for all military, covers complex situations)
• TurboTax Military (free for E-1 to E-5)
• H&R Block Military (free)

All three handle CZTE automatically if your W-2 is correct.

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Real-World Example: E-5 12-Month Deployment

Profile:

• Rank: E-5 with 6 years
• Base Pay: $3,500/month
• BAH: $1,773/month (Fort Hood, with dependents)
• Deployment: 12 months in Kuwait
• Family: Spouse + 2 kids

Income Breakdown:

Combat Zone Pay (Tax-Free):

• Base pay: $3,500/month × 12 = $42,000
• HFP: $225/month × 12 = $2,700
• Total tax-free: $44,700

Taxable Pay:

• BAH: $1,773/month × 12 = $21,276
• BAS: $460/month × 12 = $5,520
• FSA: $250/month × 12 = $3,000
• Total taxable: $29,796

Tax Savings:

Without CZTE (normal year):

• Total income: $42,000 + $29,796 = $71,796
• Federal tax: ~$7,800 (12-22% brackets)
• State tax: ~$2,150 (3%)
• Total taxes: ~$9,950

With CZTE (deployment year):

• Taxable income: $29,796 (only BAH/BAS/FSA)
• Federal tax: ~$1,200 (10-12% brackets)
• State tax: ~$890 (3%)
• Total taxes: ~$2,090

Tax Savings: $7,860

What to Do with $7,860?

Option A: Max SDP

• Deposit $10,000 in SDP
• Earn $1,291 interest (tax-free)
• Total: $11,291

Option B: Max TSP

• Contribute $23,500 to Roth TSP (tax-free)
• Future value (30 years at 9%): $311,000

Option C: Pay Off Debt

• Eliminate $7,860 in credit card debt
• Save ~$1,600/year in interest (20% APR)

Smart Move: Max SDP first, then TSP, then debt.

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Common Mistakes That Cost Money

Mistake #1: Not Adjusting TSP Contributions

Problem: Deploy with 5% TSP, miss opportunity to invest tax-free income.

Cost: E-5 could have contributed $19,200 more during 12 months, future value = $254,000.

Fix: Increase TSP to 50-75% as soon as you arrive in combat zone.

Mistake #2: California Residents Not Filing Form FTB 3913

Problem: CA doesn't automatically follow federal CZTE. If you don't file the form, CA taxes your combat pay.

Cost: E-5 with $42,000 combat pay = ~$4,200 in unnecessary CA state tax (10% bracket).

Fix: File CA Form FTB 3913 every year you have combat zone income.

Mistake #3: Signing Reenlistment Bonus Before Deployment

Problem: Sign in April, deploy in June. Bonus is taxable.

Cost: $30,000 bonus = $6,600 in taxes.

Fix: If your reenlistment window allows, sign IN the combat zone.

Mistake #4: Not Maxing SDP

Problem: Only deposit $5,000 in SDP when you could afford $10,000.

Cost: Miss out on $645 in guaranteed 10% interest (on the other $5,000).

Fix: Max SDP first, THEN save elsewhere.

Mistake #5: Forgetting to File Taxes

Problem: Think "my income was tax-free, no need to file."

Cost: Miss refunds, trigger IRS notices, complicate future returns.

Fix: Always file, even if Box 1 on W-2 is $0.

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Next Steps

Immediate Actions (Before Deployment):

1. Check Combat Zone Status: Verify your destination is IRS-designated (www.irs.gov/individuals/military/combat-zones)
2. Review TSP Allocation: Plan to increase to 50-75% once deployed
3. Research SDP: Get DD Form 2558, understand enrollment process
4. Check State Residency: Confirm your state's CZTE rules
5. Calculate Tax Savings: Use Garrison Ledger LES Auditor to project savings

During Deployment:

1. Increase TSP Contributions: Log into myPay, change percentage
2. Max SDP: Submit DD Form 2558 to finance within 30 days
3. Monitor LES: Verify CZTE is applied, FITW shows $0
4. Save Aggressively: Minimal expenses, maximum savings opportunity

After Deployment:

1. Get W-2: Verify Box 12 Code Q shows combat pay
2. File Taxes: Use MilTax or military-friendly software
3. Claim Refunds: If you had withholding pre-deployment
4. Rebalance TSP: Return to normal contribution level (5-15%)

Garrison Ledger Tools:

• LES Auditor: Calculate your exact tax savings during deployment (Dashboard → LES Auditor)
• Deployment Finance Calculator: Project SDP + TSP + tax savings (Coming Soon)
• TSP Optimizer: Plan your deployment TSP strategy (Coming Soon)

Official Resources:

• IRS Combat Zones: www.irs.gov/individuals/military/combat-zones
• IRS Publication 3: www.irs.gov/pub/irs-pdf/p3.pdf (Armed Forces' Tax Guide)
• DFAS Tax Info: www.dfas.mil/taxes
• MilTax (Free): www.militaryonesource.mil/financial-legal/tax-resource-center/miltax

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Verification Checklist

Before deployment, verify:

• [ ] Your deployment location is IRS-designated combat zone
• [ ] You understand which pays are tax-free vs. taxable
• [ ] You've planned TSP increase (50-75%) for deployment
• [ ] You've researched SDP enrollment process
• [ ] You know your state's CZTE rules (especially CA/PA residents)
• [ ] You've calculated projected tax savings
• [ ] You have a plan for using tax savings (SDP, TSP, debt, emergency fund)

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Advanced CZTE Strategies

Multi-Deployment Scenarios

Multiple Deployments in Same Year:

• CZTE applies to each deployment separately
• No annual limit on combat zone months
• Each deployment resets the 30-day SDP eligibility
• Strategy: Max SDP on each deployment, continue TSP contributions

Back-to-Back Deployments:

• CZTE continues between deployments if in combat zone
• SDP can be maintained between deployments
• TSP contributions continue tax-free
• Strategy: Maintain high TSP contributions throughout

Contractor vs Military CZTE Comparison

Military CZTE Benefits:

• Unlimited base pay exclusion (enlisted)
• SDP access (10% APY)
• TSP tax-free contributions
• Government-provided benefits

Contractor CZTE Benefits:

• Limited to $9,801.90/month (2025)
• No SDP access
• No TSP access
• Must provide own benefits

Financial Impact:

• Military E-5: $42,000 tax-free + SDP + TSP benefits
• Contractor: $117,622.80 tax-free (capped) + no SDP/TSP
• Military advantage: $10,000+ in additional benefits

State-by-State Tax Treatment Deep Dive

California (Most Complex):

• Form FTB 3913 required annually
• Combat zone pay IS tax-free
• Must file even if no other CA income
• Penalty for not filing: $100 minimum

Texas (Military-Friendly):

• No state income tax
• No additional forms required
• Maximum tax savings already achieved

Virginia (Bonus Benefits):

• Follows federal CZTE rules
• Additional $15,000 military pay subtraction
• Very military-friendly state

Pennsylvania (Complex Rules):

• Combat zone pay is tax-free
• Must file PA Schedule SP
• Complex calculation required

Audit Protection Strategies

Documentation Requirements:

• Deployment orders showing combat zone designation
• LES showing HFP/IDP pay
• Travel vouchers showing combat zone service
• Unit deployment records

Common Audit Triggers:

• High income with low taxes
• Missing combat zone documentation
• Incorrect state tax filing
• SDP/TSP contribution discrepancies

Protection Strategies:

• Keep all deployment documentation
• File state tax forms correctly
• Maintain detailed financial records
• Use military tax software (MilTax)

Filing Strategies for Maximum Benefits

Timing Your Tax Filing:

• File early to get refunds quickly
• Use combat zone pay for next year's contributions
• Plan TSP contributions for tax optimization
• Coordinate with spouse's tax situation

Married Filing Jointly Benefits:

• Spouse's income may push you into higher bracket
• Combat zone pay reduces overall tax burden
• More room for TSP contributions
• Better tax planning opportunities

Single vs Married Tax Impact:

• Single: Higher tax brackets, more benefit from CZTE**
• Married: Lower brackets, but spouse income affects planning**
• Strategy: Plan TSP contributions based on filing status**

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CZTE Success Stories

E-5 Sergeant's 12-Month Deployment

Sergeant Martinez, E-5, 6 years TIS, Afghanistan deployment

Financial Results:

• Tax Savings: $8,400 (federal) + $2,100 (state) = $10,500
• SDP Earnings: $1,000 (10% APY on $10,000)
• TSP Contributions: $24,000 (tax-free)
• Total Benefits: $35,500 in tax savings and investment growth

Post-Deployment Impact:

• Emergency Fund: $15,000 (6 months expenses)
• TSP Balance: $24,000 additional contributions
• SDP Withdrawal: $11,000 available
• Financial Security: Significantly improved position

O-3 Captain's 18-Month Deployment

Captain Johnson, O-3, 8 years TIS, Iraq deployment

Financial Results:

• Tax Savings: $12,600 (federal) + $3,150 (state) = $15,750
• SDP Earnings: $1,500 (18 months at 10% APY)
• TSP Contributions: $35,250 (tax-free)
• Total Benefits: $52,500 in tax savings and investment growth

Post-Deployment Impact:

• Home Purchase: $25,000 down payment from deployment savings
• TSP Balance: $35,250 additional contributions
• Emergency Fund: $20,000 (8 months expenses)
• Investment Account: $15,000 in index funds

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CZTE Troubleshooting

Common Issues and Solutions

Issue: CZTE not showing on LES

• Solution: Contact finance office immediately
• Verification: Ensure you're in designated combat zone
• Documentation: Keep deployment orders and travel vouchers

Issue: State tax still being withheld

• Solution: Check state tax rules and filing requirements
• California: File Form FTB 3913
• Pennsylvania: File Schedule SP
• Other states: Verify they follow federal rules

Issue: SDP not available

• Solution: Must be in combat zone for 30+ consecutive days
• Timing: Submit DD Form 2558 within 30 days of eligibility
• Finance Office: Contact finance office for assistance

Issue: TSP contributions not tax-free

• Solution: Ensure contributions are from combat zone pay
• Verification: Check LES for CZTE designation
• Timing: Contributions must be made while in combat zone

Emergency Situations

Early Return from Deployment:

• CZTE continues for partial month
• SDP remains available if 30+ days served
• TSP contributions remain tax-free for time served
• File taxes normally with partial year CZTE

Deployment Extension:

• CZTE continues for extended time
• SDP can be maintained
• TSP contributions continue tax-free
• Plan for extended deployment benefits

Family Emergency During Deployment:

• Emergency leave may affect CZTE
• Consult finance office for specific rules
• Documentation required for exceptions
• Plan for potential tax implications

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CZTE Resources and Support

Military-Specific Resources

• Finance Office: CZTE questions and SDP setup
• Legal Office: Tax implications and legal advice
• Family Support: Financial counseling and resources
• Military OneSource: 24/7 support and tax assistance

Tax Professional Help

• MilTax (Free): Military-specific tax software
• VITA Program: Free tax preparation for military
• Military Tax Professionals: Specialized military tax help
• State Tax Assistance: State-specific tax help

Online Resources

• IRS Military Tax Center: Official IRS military tax information
• DFAS Tax Information: Military pay and tax information
• State Tax Websites: State-specific tax rules and forms
• Military Tax Forums: Online community support

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CZTE is the biggest "raise" you'll get during your military career. An E-5 can save $10,000+ in taxes during a 12-month deployment. Don't waste it - max SDP, max TSP, and come home financially stronger.

🎖️ Deploy smart. Save smarter.