In recognition of the importance and sacrifices associated with military service, many employers provide a supplemental payment for their employees called to active military service which covers the difference between their military pay and their regular compensation. Pay differentials are provided for varying lengths of time.

Revenue Ruling 2009-11 provides that a differential wage payment made by employers to their employees that leave their job to go on active military duty is not subject to FICA or FUTA taxes. However, the pay differential is subject to income tax withholding under new Code section 3401(h). The IRS 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.

Section 3401(h) was added to the Code by section 105(a) of the Heroes Earnings Assistance and Relief Tax Act of 2008.  New subsection 3401(h) 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. Section 3401(h) applies to differential wage payments paid after December 31, 2008. The enactment of section 3401(h) modifies the holding in Revenue Ruling 69-136 that differential wage payments are not subject to income tax withholding. The term “differential wage payment” means any payment which (A) is made by an employer to an individual with respect to any period during which the individual is performing service in the uniformed services (as defined in chapter 43 of title 38, United States Code) while on active duty for a period of more than 30 days, and (B) 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.

We have previously summarized the provisions of HEART in our post Making Sure Your “HEART” Is In The Right Place When It Comes To Soldier-Employee’s Benefits