“Differential Wage Payments” During Active Military Service Subject to Income Tax But Not FICA, FUTA

Payments by employers to employees while they are on active military duty for more than 30 days are subject to withholding for federal income tax but are not taxed under the Federal Insurance Contributions Act (FICA) or Federal Unemployment Tax Act (FUTA), the IRS said in Revenue Ruling 2009-11, issued Wednesday.

To determine the amount of withholding, for total annual compensation of less than $1 million, employers may aggregate differential pay with ordinary wages or withhold at an optional 25% flat rate.

Some employers with employees who enlist in or are called to active military service continue paying them the difference between their regular wages and their governmental military pay. Such “differential wage payments” during temporary military service have been considered wages subject to payroll taxes. Revenue Ruling 69-136, 1969-1 CB 252, provided that where individuals ended their employment upon entering active military service, differential pay by former employers was not wages within the meaning of IRC § 3121 and therefore not subject to withholding for any income, FICA, or FUTA taxes.

In 2008, the Heroes Earnings Assistance and Relief Tax Act of 2008, PL 110-245, added new IRC subsection 3401(h) applying to differential wage payments after Dec. 31, 2008. Under it, such payments are wages subject to income tax withholding if made during a period of active military duty longer than 30 days and representing all or a portion of wages the individual would have received had he or she continued to perform services for the employer. Since section 3401(h) does not address FICA and FUTA, Revenue Ruling 69-136 continues to apply to those taxes, provided the absence is more than temporary, the Service said in the new ruling.