Leave Management, Policy, and Compliance

New IRS Guidance: Pay and Benefits During Military Leave

This content was originally published in April 2010. For the latest FMLA regulation changes, visit our FMLA article archives or try our practical FMLA compliance guide.

Although the number of military service members called to active duty has decreased somewhat, many American men and women in the National Guard and reserves continue to receive the call to duty. In an effort to alleviate the economic and other stresses of military service, the FMLA has been amended to allow for leave for qualifying exigencies and caring for family service members.

In addition, the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act) amended the federal tax code to allow employers to administer differential compensation and benefits issues, and to reward some employers for providing pay to employees who serve.

After the passage of the HEART Act, questions remained regarding the tax implications of the pay and benefits for employees serving in the military. In response, the Internal Revenue Service (IRS) recently issued Notice 2010-15 (the Notice) in Q&A-style form to clarify the initial legislation. The Notice provides guidance in the form of questions and answers with particular respect to the following sections of the Heart Act:

  • Section 104—relating to survivor and disability payments with respect to qualified military service
  • Section 105—relating to treatment of differential military pay as wages
  • Section 107—relating to distributions from retirement plans to individuals called to active duty 
  • Section 109—relating to contributions of military death gratuities to Roth IRAs and Coverdell education savings accounts
  • Section 111—relating to an employer credit for differential wage payments to employees who are active duty members of the uniformed services 

Some of the information in the Notice is provided below. For more information and to see IRS Notice 2010-15, go to http://www.irs.gov/pub/irs-drop/n-10-15.pdf.

Differential Pay

When employees in the National Guard or reserves are called to active duty, some employers choose to pay some or all of the compensation that a service member would have received from the employer during the service member’s period of active duty had the employee not been called to active duty.

Prior to the HEART Act, these payments, commonly referred to as “differential wage payments,” were not treated as wages for federal employment tax purposes, pursuant to IRS Rev. Rul. 69-136, 1969-1 C.B. 252.

Section 105(a) of the HEART Act amended § 3401 of the tax code to treat differential wage payments as wages for income tax withholding purposes. The term “differential wage payment” is defined in §3401(h) as any payment that:

(1) Is made by an employer to an individual with respect to any 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

(2) Represents all or a portion of the wages the individual would have received from the employer if the individual were performing service for the employer.

Important: Differential wage payments made to an individual while on active duty in the U.S. uniformed services for more than 30 days are subject to income tax withholding, but are not subject to FICA or FUTA taxes. For more information on the tax treatment of differential wage payments during military service, see IRS Rev. Rul. 2009-11.

Tax Credit for Employers

The HEART Act also provides a tax credit for eligible small business employers that make eligible differential wage payments to employees while serving in the military in the National Guard or reserve forces. The credit is equal to 20 percent of the sum of the eligible differential wage payment paid to each qualified employee during the taxable year (IRC Sec. 45P).

An “eligible small business employer” for a taxable year is an employer that employed an average of fewer than 50 employees on business days during the taxable year and made eligible differential wage payments under a written plan to every qualified employee of the employer. No credit is allowed if an employer violates the employment or reemployment rights of a reservist who has been called to active duty.

A “qualified employee” is a person who was employed by the employer claiming the credit for the 91-day period immediately preceding the period for which any differential wage payment is made.

Benefits

In addition to questions regarding withholding and tax credits, employers questioned the effect of the HEART Act on benefits such as death or disability while performing military service, distributions for qualified retirement plans, plan amendments, and other issues surrounding retirement.

In response, the IRS Notice 2010-15 provides examples of the types of benefits to which survivors could be entitled under the Act. Most notably, the Notice clarifies that:

  • Survivors are entitled to any accelerated vesting or ancillary life insurance benefit provided under the Plan.
  • The Act applies to any benefit due to a survivor that is contingent on the participant’s death.
  • When an employer pays differential wage payment, the amounts paid are treated as compensation for purposes of qualified retirement plans. However, employers are not required to treat differential wage payments as compensation in determining a participant’s benefit under a Plan.
  • If a qualified retirement plan participant is called to active duty for 31 days or more, he or she is entitled to take a distribution from the plan which is not subject to the 10 percent early withdrawal tax. An employer that chooses to provide for this special distribution must impose a 6-month restriction on elective deferrals or other employee contributions for any participant who takes such a distribution.
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