I think I've actually been killed more often by own friends panicking and shooting me by accident (thinking I'm a bad guy) than actual people shooting at us.
I would like to propose the following solution: Another wearable item, that you can colour in using spray paint, that can be worn over the sleeve.
I was thinking you could construct them from rags - tear apart a shirt, paint it and then choose an arm, rather than have them as another item to be found in game.
It would be nice if the player can choose which arm (or perhaps even a leg) to wear it on, to allow for more subtle methods of identification.
Should time allow, you could allow the player to get creative and paint patterns onto the arm band, rather than having it as a single solid colour.