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For the past 5 years, I claimed CZTE or Combat Zone Tax Exclusion income on my tax returns. Every year after I file my taxes, I receive a CP04 Notice from the IRS, asking to verify that I am eligible for tax exemption.
The first time I received the letter I was nervous to receive an inquiry from the IRS. However, after asking around the squadron it seemed like everyone received one of these letters if they claimed CZTE pay on their taxes.
You can see your CZTE pay listed on your W-2 form in Box 12 under the “Q” code. The amount listed after the Q code is tax exempt military pay from any month you were in a designated combat zone.
This is not an audit or the IRS calling you a liar! They are simply looking for additional information in regards to your claim of serving in a combat zone. See more information on the IRS website here.
How to Respond to an IRS CZTE Inquiry
First, gather your information. I find it useful to save a PDF copy of my LES in my Google Drive every month because MyPay only keeps the last 12 LES.
This way I have a permanent record of what I have been paid and what has been deducted. It also keeps a record of when I hit tax free areas.
I write down the months I hit a tax free area which is usually the month before the CZTE is paid. You can see if CZTE was reimbursed to you with the line in entitlements “FITW REFUND (CZ).” “FITW” is Federal Income Tax Withholding and “CZ” is Combat Zone.
You can also check the notes of the LES at the bottom. It should display the dates you are eligible for combat zone entitlements: “COMBAT ZONE 170201-170228(702)”.
The CP04 only provides three lines for date of entry and date of exit. If you entered and exited more frequently than that, just include a copy of your orders showing the relevant information.
I have included CED orders and DTS TDY orders with CZTE locations highlighted.
Once I have gathered my dates and paper copies of my orders, I will redact any information I do not feel is relevant to the IRS inquiry.
If there are classified or sensitive locations listed on any of the orders, I remove them with the redaction tool in Adobe Acrobat PDF viewer.
Then just mail the orders and CP04 form back to the IRS in the included postage paid envelope. I have never had a second inquiry by following the method above.
Have you ever had a CZTE or CP04 inquiry from the IRS? How did you respond to it? Have you ever had any follow up inquiries or audit because of CZTE income? Let us know in the comments.