Military Differential Pay
Note: Rules for reporting military differential pay changed Jan. 1, 2009. The answers below reflect the current information. For information on reporting military differential pay before 2009, see Publication 15 for the appropriate year.
Q-36: What is military differential pay?
A-36: Some employers voluntarily agree to continue paying full wages to their employees who are called to active duty. This is commonly referred to as differential pay. Differential pay is any payment made by an employer to an individual for a period during which the individual is performing service in the uniformed services while on active duty for a period of more than 30 days and represents all or a portion of the wages the individual would have received from the employer if the individual were performing services for the employer.
Q-37: If an employer pays military differential pay to an employee called to active duty, are these payments considered wages?
A-37: Yes, for income tax purposes.
Q-38: What is the tax treatment of military differential pay?
A-38: Beginning in 2009, military differential pay is wages and should be reported in box 1 of Form W-2 as wages for income tax purposes. Military differential pay is includible as wages for income tax purposes on Form W-2, but is excludable from social security and Medicare taxes (FICA).
Certain compensation paid by state or local government that is received for active service in a combat zone by members of the Armed Forces of the United States is excludable from gross income. Combat zone pay is not military differential pay.
Q-39: If an employee is called to active duty and receives military differential pay, how are these payments reported by the employer to the employee?
A-39: Employers should report military differential pay as wages in box 1 of Form W-2. These amounts are subject to withholding for income tax and should be reported on Form 941.
Q-40: How does a person who receives military differential pay report this on the federal income tax return?
A-40: These amounts are included in wages on Line 7 of Form 1040.
Social Security Taxes (FICA)
Q-41: Are there any benefit reductions due to FICA not being withheld by the employer?
A-41: Military personnel have FICA taken out of their military pay even when serving in a combat zone. Thus, they will get Social Security credit for their military earnings. However, Social Security retirement benefits are based on a worker’s total earnings history. Since the military differential pay is not subject to FICA, the person’s Social Security retirement benefits may be reduced.
Q-42: How does an employer correct the Form 941 (Quarterly Employment Tax Return) if FICA and income taxes have been erroneously withheld?
A-42: File a separate Form 941-X, Adjusted Employer's QUARTERLY Federal Tax Return, for each Form 941 that needs to be corrected. If you reported too much FICA or income tax, you can use this form to either make an interest-free adjustment or file a claim for refund or abatement. You must provide background information and certifications supporting any prior quarter adjustments. Form 941-X can also be used to correct underreported tax and, if done properly, is generally interest-free and penalty-free. See Form 941-X and its instructions for details.
Q-43: How does an employee recover FICA taxes that were erroneously withheld by the employer?
A-43: Employees are encouraged to contact their employers and request that they seek a refund of the erroneously withheld FICA on the employees' behalf. Because employers also pay a portion of FICA that is not withheld from payments to the employee, the employer will also be entitled to a refund. The employer may have other similarly situated employees who are entitled to refunds and the IRS can process a single refund claim filed by the employer more efficiently than it can process numerous refund claims filed by individual employees. If the employer refuses to seek a refund on the employee's behalf, the employee may file a refund claim using Form 843. Line 5 is where the employee explains the reaseon for the refund and efforts made to secure it. The employee's claim for refund must include a statement from the employer indicating whether the employer has reimbursed any of the erroneously withheld FICA to the employee or filed a refund claim for any of the erroneously withheld FICA.
Q-44: What is the tax treatment of health care benefits and coverage while the employee is on active military duty?
A-44: Generally, the gross income of an employee does not include employer-provided coverage under an accident or health plan or employer contributions to such plans. This exclusion from gross income extends to employees who are on military leave. The value of employer-provided coverage, or employer contributions to accident or health plans, are not reported on the Form 1099-MISC given to the employee.
Q-45: Is the cost of group term life insurance included in gross income while the employee is on military pay?
A-45: The tax treatment of group term life insurance coverage provided to employees on military leave is the same as coverage provided to current employees. Generally, the cost of $50,000 of group term life insurance coverage is not included in gross income while the employee is on military leave.
Q-46: If an employer pays an employee who is called to active duty his vacation pay is this pay subject to social security, Medicare and income taxes?
A-46: Yes, vacation pay that is earned or accrued prior to the worker being called for active duty or active service is subject to withholding as if it were a regular wage payment, even if paid to the worker after activation. When vacation pay is in addition to regular wages for the vacation period, treat it as a supplemental wage payment. If the vacation pay is for a time longer than your usual payroll period, spread it over the pay periods for which you pay it. Vacation pay that is earned or accrues after the employment relationship is terminated by activation is not a wage payment.
Q-47: If a co-worker wants to donate vacation time to an employee who is called to active duty to whom is such leave taxable?
A-47: The donated vacation time is taxable to the recipient of the vacation time. As a result, the employee on active duty receiving donated vacation pay is subject to withholding of social security, Medicare and income taxes as if it were a regular wage payment. When vacation pay is in addition to regular wages for the vacation period, treat it as a supplemental wage payment. If the vacation pay is for a time longer than your usual payroll period, spread it over the pay periods for which you pay it.
Q-48: An employee received an award from the employer and wishes to donate it to a co-worker who has been called to active duty. To whom is the award taxable?
A-48: The award is taxable to the recipient. The recipient’s award is subject to withholding of social security, Medicare and income taxes as if it were a regular wage payment. When an award is in addition to regular wages, treat it as a supplemental wage payment.
Reference for questions 44-48: Publication 15, Employer’s Tax Guide (PDF 344K)
For more details on tax issues related to military service, see Publication 3, Armed Forces' Tax Guide ( PDF 166K).