Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 54-40

1954-1 C.B. 222

IRS Headnote

Cost-of-living allowances, paid to certain civilian employees of the Government of the United States stationed outside the United States, are not `wages' subject to the withholding of income tax at the source under section 1622 of the Internal Revenue Code. Whether such allowances are `wages' subject to Federal employment taxes is to be determined, under section 1420(e) of the Code, by the head of the Government agency involved.

Full Text

Rev. Rul. 54-40

Advice is requested whether cost-of-living allowances, paid to certain civilian employees of the Government of the United States stationed outside of the continental United States, are subject to the Federal Insurance Contributions Act taxes or to the withholding of income tax under section 1622 of the Internal Revenue Code.

Section 204 of the Independent Offices Appropriation Act of 1949, approved April 20, 1948, 62 Stat. 194, as extended, provides for the payment, in accordance with regulations prescribed by the President, of cost-of-living allowances to civilian officers and employees of the Government of the United States stationed in foreign countries.

Section 207 of the Independent Offices Appropriation Act, supra , as amended by section 104 of the Supplemental Independent Offices Appropriation Act of 1949, approved June 30, 1948, 62 Stat. 1205, authorizes payment of similar allowances, in accordance with regulations prescribed by the President, to certain civilian employees of the Government of the United States stationed in Territories and possessions of the United States.

In view of the purposes for which the aforementioned cost-of-living allowances are provided the employees in question, it is believed that such payments do not constitute `wages' within the meaning of the Federal Insurance Contributions Act or of section 1621(a) of the Internal Revenue Code, relating to the withholding of income tax at the source.

Accordingly, it is held that an amount, which is specifically identified as a `cost-of-living allowance,' paid to a civilian employee of the Government of the United States stationed outside the continental United States or in Alaska, pursuant to sections 204 or 207 of the Independent Offices Appropriation Act of 1949, supra , as amended and extended, and in accordance with applicable regulations thereunder prescribed by the President, is not subject to the withholding of income tax under section 1622 of the Internal Revenue Code. However, a payment which is compensatory in nature, such as a `post differential' paid to an employee for service at a post where conditions of environment have been deemed to warrant the payment of additional compensation as a recruitment incentive, is subject to the withholding of income tax under section 1622 of the Code.

It is the opinion of the Internal Revenue Service that the status of the `cost-of-living allowance' and of the `post differential' for purposes of the Federal Insurance Contributions Act would be the same as for purposes of income tax withholding. However, attention is directed to section 1420(e) of the Internal Revenue Code, which provides in substance that in the case of taxes imposed by the Federal Insurance Contributions Act with respect to service performed in the employ of the United States or of a wholly owned instrumentality thereof, the determination whether an individual has performed service which constitutes employment, the determination of the amount of remuneration for such service which constitutes wages, and the return and payment of the taxes imposed thereon, shall be made by the head of the Federal agency or instrumentality having the control of such service, or by such agents as such head may designate.