IRS: Differential Pay to Workers on Military Duty Is Subject to Income Tax Withholding

Revenue Ruling 2009-11 provides that differential pay that employers pay to their employees that leave their job to go on active military duty is subject to income tax withholding, but is not subject to Federal Insurance Contributions Act (“FICA”) or Federal Unemployment Tax Act (“FUTA”) taxes. Additionally, the ruling provides that employers may use the aggregate procedure or optional flat rate withholding to calculate the amount of income taxes required to be withheld on these payments, and that these payments must be reported on Form W-2.

The underlying facts are as follows: M, an employer, has employees who are called or voluntarily enlist for active military service in the United States uniformed services (as defined in chapter 43 of title 38, United Sates Code) for periods exceeding 30 days. M continues making payments to the individuals in an amount equal to the difference between the compensation they receive for their military service and the wages the employees would have received from M if the employees were performing services for M. The payments supplement compensation received by the employees from the Federal government for their military service.

The issues are:

1. Are differential wage payments made by employers to individuals while on active duty in the uniformed services of the United States for more than 30 days ”wages” for purposes of taxation under the Federal Insurance Contributions Act (“FICA”), the Federal Unemployment Tax Act (“FUTA”), and the Collection of Income Tax at Source on Wages (income tax withholding)?

2. How do employers calculate the amount of income taxes required to be withheld on differential wage payments?

3. What information return reporting requirements apply to differential wage payments?

Given the foregoing, the Internal Revenue Service (“IRS”) held that:

1. 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.

2. Employers may use either the aggregate method or optional flat rate withholding to calculate the amount of income tax required to be withheld on differential wage payments which do not exceed $1,000,000 when added to all other supplemental wages paid by the same employer to the individual during the calendar year.

3. The amounts of the differential wage payments must be reported by the employer on the employee’s Form W-2.

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