Beth Hoffman, a 37 year-old military widow living in Manassas, Va., was working on her income taxes this year when she got a rude shock: Her bill had gone up by about $5,000 from the previous year.
Hoffman hadn’t gotten a better job with higher pay in the last year — she’s a stay-at-home mom who receives federal benefits that her husband Matt earned following his death while on active duty in 2011. Technically, the government was sending the bill to her nine year-old son, Joey, who is the beneficiary of his father’s Defense Department insurance annuity.
“I thought: That can’t be right,” Hoffman said. She told the Washington Examiner that she asked, at her own expense, four different tax attorneys, including the Judge Advocate General’s Corps, to find a mistake, but all said that the bill was correct.
“This was on top of what was already being withheld. In total, my nine-year-old has paid almost $10,000 in taxes,” she said. She had no inkling it was coming and therefore hadn’t saved up, so to pay it she had to dip into college savings for her son.
It turned out she wasn’t alone. Other Gold Star families who receive federal benefits earned by a fallen soldier saw similar hikes to their tax bills this year. The number may be in the thousands, given the number of families who receive the benefits.
The families were the inadvertent victims of attempt by Congress to prevent the wealthy from dodging taxes. It was caused by a change included in the Tax Cuts and Jobs Act, the 2017 tax overhaul bill passed by Republicans and signed by President Trump, that reclassified the “unearned income” received by children.
The intention, according to congressional aides and others involved in the bill’s drafting, was to close a loophole in which the rich were shifting income to their kids in the form of trusts order to avoid the estate tax. The aides said that nobody at the time realized the impact the change would have on military families — and some pointed out that if it had been known, Democrats would have had a field day criticizing it.
“We didn’t see it coming either,” said Candace Wheeler, senior adviser for policy for the Tragedy Assistance Program for Survivors, a nonprofit advocacy group that works with military families and closely follows the tax issue.
Military families hit with the tax hike were already facing a separate, long-standing tax problem regarding their federal benefits. Critics in Congress have dubbed the problem the “military widow’s tax.”
Many families of lost service members receive benefits from both the Defense Department, through its Survivor Benefits Plan, an insurance annuity, and the Veterans Affairs Department’s Dependency and Indemnity Compensation program.
However, the families are not allowed to receive both benefits, so there is a dollar-for-dollar reduction in the DoD benefits if they also get the VA one. For most families, the provision eliminates the DoD benefit altogether, since the VA benefit is typically larger, at $16,000 for most families. An estimated 62,000 widows are subjected to this penalty, according to the Tragedy Assistance Program for Survivors, which has tried for years to end the double-dipping penalty on the families.
To get around the problem, many families have put the Defense Department benefit in a child’s name. The benefit is still subject to taxation, which until last year in most cases was at the same tax rate the parent paid on income. It expires when the child reaches 18 years old, or 22 if they are a student. It is unclear how many of the families facing the “military widow’s tax” have used this workaround, but its existence was widely known among veterans groups.
For Hoffman, the maneuver meant financial flexibility. “My son is able to play baseball and be involved in [as] many things as he can,” she said. “It also allowed me to not force myself to have to go back to work and be away from my son.”
Hoffman bristles at the notion that the benefits are unearned income. “This replaces a check that stopped coming when my husband died,” she said.
That flexibility ended with the 2017 overhaul.
The tax rates for trusts were rewritten with the intention of ending any incentive to shift income to children. Contributions to those trusts were previously taxed at the parents’ income tax rates. The reform changed that to the higher estate tax rate. The change, which no one in Congress has taken responsibility for, was suggested at least as early as 2014 in prior tax reform proposals. The intention was widely understood at the time as preventing the wealthy from using their children as a means to evade the estate tax.
The tax-raising tightening of the estate tax rules was balanced out, or so it was thought, by one of the main features of the tax bill: Doubling the estate tax exemption from $5.6 million to $11.2 million, a provision that ends in 2025.
Another advantage of this approach, drafters thought, was that it made the code simpler. Taxing the trusts at the parents’ rate could create complicated situations if the parents were separated or divorced. Using an estate tax rate instead eliminated that issue.
“As somebody who has prepared taxes with kiddie tax elements, it got a lot easier. So it did simplify things,” noted Ryan Ellis, a tax lobbyist.
The revelation that military have families were caught up in the attempt to get the wealthy has prompted a scramble in Congress to fix the issue.
“The Military Widow’s Tax is unconscionable—but raising taxes on the benefits our fallen servicemembers’ children receive is appalling,” tweeted Sen. Doug Jones, D-Ala., on Monday. Jones has introduced the Military Widow’s Tax Elimination Act, which would end the prohibition on double-dipping the benefits. Rep. Joe Wilson, R-S.C., has introduced a companion House version dubbed the Military Surviving Spouses Equity Act.
On Thursday, a bipartisan group of lawmakers introduced the Gold Star Family Tax Relief bill. The legislation, authored by Rep. Elaine Luria, D-Va., would clarify that any survivor benefit provided by the Department of Defense or the Department of Veterans Affairs and going to the child of a fallen service member would not be classified as unearned income.
“When it was brought to our attention that simplification of the tax in 2017 was having unintended consequences for our Gold Star families, we worked quickly and on a bipartisan basis to find a solution that is fair and will also offer retroactive relief for affected families,” said Rep. Kevin Brady, R-Texas, the top Republican on the Ways and Means Committee, a cosponsor of Luria’s bill.
