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Employers managing leave issues for employees in the military now have more definitive guidance from the Internal Revenue Service (IRS) on how to handle taxation of differential military pay. IRS Revenue Ruling 2009-11, issued in the early part of 2009, addresses tax credits and the tax treatment of differential pay for various types of military service.
Although employers are not required to pay employees who are on military leave, those companies that do provide for continuing an employee’s pay during periods of military service quite often pay only the difference between the employee’s regular salary and military pay. In computing military pay, food and other allowances given to officers are usually excluded.
Although employers are not required to pay wage differentials to those in military service, if they promise to do so by policy, contract, or both, they are obliged to pay, or face double damages under USERRA if the pay is improperly withheld.
Tax Credit for Differential Wage Payments
The Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act) provides a tax credit for eligible small business employers that make eligible differential wage payments. 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. Payments made on or after June 17, 2008, and before January 1, 2010, are eligible for the credit.
A “differential wage payment” is any payment made by an employer to an individual for a period while 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 he or she was still performing services for the employer.
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.
Tax Treatment Of Differential Pay
The IRS has addressed the issue of the taxability of differential military pay in several revenue rulings. The various rulings addressed the application of the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and income tax on employees and employers for wages paid with respect to employment.
Active military service. The first ruling, Revenue Ruling 69-136, 1969-1 C.B. 252, addresses the tax treatment of payments made by civilian employers to their employees who are called to or enlist in active military service for an extended time period.
The payments in question in the ruling were made by the civilian employers during the period of active military service in amounts equal to the difference between the compensation paid by the military and the wages that would have been paid if the individuals were performing services for the civilian employer.
The IRS held that the payments were not wages subject to the taxes imposed by FICA or FUTA or to income tax withholding.
State National Guard. Revenue Ruling 68-238, 1968-1 C.B. 420, addressed the tax treatment of payments made by civilian employers to their employees who were temporarily absent from work while serving in a state National Guard. The payments were equivalent to the difference between the employees’ normal wages and the amounts received from the state for their services in the National Guard.
The IRS held in that ruling that the payments were wages and were subject to FICA and FUTA taxes, as well as income tax withholding.
HEART Act. The HEART Act (discussed earlier) provides that, for purposes of income tax withholding, any differential wage payment is to be treated as a payment of wages by the employer to the employee. The term “differential wage payment” means any payment 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 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. The HEART Act modifies the holding in Revenue Ruling 69-136 (discussed earlier) in that differential wage payments that qualify under the Act are not subject to income tax withholding.
As a result of these revenue rulings, differential wage payments made to an individual while on active duty in the United States 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 Revenue Ruling 2009-11 on the IRS; website, www.IRS.gov.