Individual Income Taxes
Tax Provisions of Special Interest to Federal Employees and Retirees
Pay and Benefits Related to Civilian Federal Service
Social Security and Medicare Payroll Taxes—Civil Service Retirement System employees do not pay Social Security taxes; instead, they pay only into the federal retirement fund. Employees under the Federal Employees Retirement System and under CSRS Offset pay the Social Security payroll tax (commonly called the FICA tax) of 6.2 percent on income up to an annual limit: $128,400 in 2018, $132,900 in 2019 (in addition, CSRS Offset employees pay 0.8 percent into the federal retirement fund). Above that level the Social Security tax stops for FERS employees, while CSRS Offset employees continue to pay the same total 7 percent contribution toward retirement but with all of the contribution going into the federal retirement fund. All employees also pay the Medicare tax of 1.45 percent of salary with no limit. See Mandatory Deductions in Chapter 1, Section 10.
Flexible Spending Accounts—Employees who make contributions into flexible spending accounts reduce their taxable income. The 2018 limit for health care account contributions was $2,650 per person and for dependent care accounts $5,000 per individual/couple. Unused balances in health care accounts of up to $500 can be carried from one plan year to the next, provided the account holder has an account in the second year; otherwise the remaining balance is forfeited. For dependent care accounts there is a grace period of two-and-half months into the following year for charging eligible costs against the account for the prior year. Retirees are not eligible for FSAs. See Chapter 1, Section 10.
Insurance Premiums—Active federal employees may pay their Federal Employees Health Benefits program premiums on a pre-tax basis; while employees must pay premiums in the Federal Employees Dental and Vision Insurance Program on that basis. Retirees are not eligible apart from a limited exception for retired public safety officers. See Pretax Treatment of FEHB Insurance Premiums in Chapter 2, Section 1 for the covered occupations and other rules. (Note: That exception also applies for payment of premiums under the Federal Long Term Care Insurance Program.)
Thrift Savings Plan—Employees who make “traditional” investments in the TSP defer paying taxes on those investments and their earnings until they withdraw them. “Roth” investments are made with after-tax money (unless from tax-exempt combat pay). For FERS employees, all agency automatic and matching contributions are invested in traditional balances and are taxable along with their earnings on withdrawal. Retirees are not eligible to make new TSP investments. See Chapter 6, Section 1.
On withdrawal after retirement (or separation for other reasons), traditional balances are fully taxable. Roth investments are withdrawn tax-free, and their earnings also are not taxable as long as certain conditions are met. See Chapter 6, Section 4.
In addition, there are potential tax consequences of taking loans and in-service withdrawals, including a potential 10 percent penalty for taking withdrawals before age 59 ½. See Chapter 6, Section 3.
Federal Employees’ Compensation Act—FECA payments you receive for personal injuries or sickness resulting from the performance of your duties are tax exempt and aren’t treated as disability income or annuities. However, payments you receive while your claim is being processed, including pay while on sick leave and continuation of pay for up to 45 days, are taxable.
Lump-sum Payments for Unused Annual Leave—A payment for unused annual leave received on separation is considered a salary payment and is taxable as wages in the tax year you receive it.
Voluntary Contributions Accounts—If you choose a lump-sum withdrawal of a voluntary contributions account (see CSRS Voluntary Retirement Contributions in Chapter 3, Section 3), the interest is taxable to you in the tax year it is distributed, and tax will be withheld at a 20 percent rate, unless you roll it over to a traditional IRA or another qualified retirement plan.
If you choose to receive an additional annuity with a voluntary contributions account, that benefit is treated separately from your regular annuity benefit even if you receive a combined monthly payment. Each year you will receive a Form CSA 1099-R that will show how much of your total annuity received in the past year was from each type of benefit. Figure the taxable and tax-free parts of your additional monthly benefits from voluntary contributions using the rules that apply to regular annuity benefits as described in Taxability of Annuities in Section 3 of this chapter.
Moving Expenses—Public Law 115-97 suspended qualified moving expense deductions along with the exclusion for employer reimbursements and payments of moving expenses effective January 1, 2018. Along with the previously taxable travel, transportation and relocation expenses under FTR Chapter 302, the following reimbursements, direct payments, and indirect payments were made taxable: lodging expenses for en route travel to the new duty station; mileage for using a privately-owned vehicle to travel to the new duty station; transportation using common carrier (e.g., airline) to the new duty station; shipment of household goods to include unaccompanied air baggage and professional books, paper, and equipment; temporary storage of household goods in transit; shipment of a mobile home in lieu of household goods; extended storage of household goods for assignments outside the continental United States; and transportation of privately-owned vehicles.
Note: The law continued the non-taxable status of residential sales through a relocation services company.
GSA Bulletin 18-05 of 2018 stated that federal agencies are required to collect supplemental wage taxes for all taxable relocation entitlements, reimbursed either directly or indirectly. However, it said they are authorized to pay withholding tax allowances and relocation income tax allowances to cover “substantially all” of the increased tax liability resulting from receipt of relocation expense reimbursements paid either directly or indirectly.
Federal Employees’ Group Life Insurance Benefits—Death benefit payments made under Federal Employees’ Group Life Insurance (see Chapter 2, Section 2) to a designated beneficiary are not taxable as income to the beneficiary. As with any life insurance policy in which the decedent had maintained incidents of ownership (the right to change the beneficiary), the proceeds are includible in the insured’s estate and may be subject to estate tax to the extent the estate is taxable.
“Living benefits” payments are not subject to federal income tax. Consult a tax advisor or your state’s tax department for information concerning state tax laws.
Affordable Care Act—The Patient Protection and Affordable Care Act, Public Law 111-148, required each individual to maintain “minimum essential coverage” each month starting in 2014 or else be subject to a penalty, unless eligible for certain exceptions. This “individual shared responsibility provision” further requires maintaining such coverage for children and others who are dependents for federal income tax purposes. All FEHB plans qualify as providing such coverage for those who are personally enrolled or who are covered under another person’s enrollment or under the spouse equity or temporary continuation of coverage provisions.
P.L. 115-97, the Tax Cuts and Jobs Act of 2017 repealed that penalty effective with tax year 2019, although it left the penalty in place for 2018, while also leaving the amount unchanged at $695. For 2018 returns, taxpayers must continue to report qualifying coverage, qualify for an exemption, or pay the penalty.
Pay and Benefits Related to Military Service
Generally, members of the Armed Forces include the same items in income as do civilians. However, certain pay and benefits resulting from service in the Armed Forces (for federal employees, related to service either before federal employment or during it as a member of the Guard or Reserves) are exempt. Also see Publication 3, Armed Forces’ Tax Guide, available at www.irs.gov.
Thrift Savings Plan—See Military Reserve TSP Accounts in Chapter 6, Section 1 for information about uniformed services Thrift Savings Plan accounts available to civilian federal employees who serve, or have served, on active military duty.
Military Retired Pay—Standard military retired pay is not exempt from income tax. Disability retirement pay that is computed on the basis of the percentage of disability is fully excludable from gross income, but disability retirement pay that is computed by reference to years of service is excludable only to the extent allowed under the percentage-of-disability method. Any pension, annuity, or similar payment for personal injury or sickness that resulted from combat related service in the Armed Forces or in the Coast and Geodetic Survey, or Public Health Service is exempt from tax.
Armed Forces Allowances—Allowances for subsistence, quarters, travel, and moving paid to any member of the Armed Forces, Coast and Geodetic Survey, or Public Health Service, are excludable from income. These include housing and cost-of-living allowances to cover the excess cost of quarters and subsistence while on permanent duty at a post outside the United States, as well as family separation allowances received on account of overseas assignment.
Combat Zone Compensation—Compensation received by an enlisted member of the Armed Forces is excluded from the taxpayer’s gross income for any month during which the taxpayer served in a combat zone or was hospitalized as a result of wounds, disease, or injury incurred while serving in a combat zone. The exclusion for months of hospitalization does not apply for any month beginning more than two years after the termination of combatant activities in the zone. For a commissioned officer, the exclusion is limited to “the maximum enlisted amount.” This amount is the highest basic pay rate at the highest pay grade that enlisted personnel may receive plus the amount of hostile fire/imminent danger pay that the officer receives.
Taxes Due from Member of Armed Forces Upon Death—If a member of the Armed Forces dies while serving in a combat zone or as a result of wounds, disease, or injury while so serving, the income tax for the year of death and any prior year ending on or after the first day served in a combat zone is canceled. Any unpaid taxes of such individual that relate to tax years prior to service in a combat zone may also be abated. A similar rule applies to deaths as a result of wounds or injury occurring outside the United States in a terrorist or military action against the United States or any of its allies.
Veterans’ Benefits—Veterans’ benefits under any law administered by the Veterans Affairs Department are not includible in income. This includes amounts paid to veterans or their families as disability compensation and pension payments, educational, training or subsistence allowances, grants for homes with wheelchair access, and grants for vehicles for veterans who lost their sight or use of their limbs.
Dividends and proceeds from maturing government endowment insurance contracts under all acts relating to veterans are exempt. Interest on dividends left on deposit with the VA is also exempt.