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Understanding the Tax Considerations of Military Differential Pay

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With today's Guardsman and reservists being called upon more often to serve longer tours, the issue of military differential pay is often raised. The following FAQ's are provided by the IRS.

Q: What is military differential pay?

A: 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: If an employer pays military differential pay to an employee called to active duty, are these payments considered wages?

A: Yes, for income tax purposes.

Q: What is the tax treatment of military differential pay?

A: Military differential pay is considered 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: 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: 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: How does a person who receives military differential pay report this on the federal income tax return?

A: These amounts are included in wages on Line 7 of Form 1040

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