Is Military Cost of Living Allowance (COLA) Taxable?

The Military Cost of Living Allowance (COLA) helps service members stationed in areas where the cost of living is significantly higher than average. This allowance aims to equalize purchasing power, ensuring military personnel and their families maintain a comparable standard of living regardless of their duty station. A frequent question concerns its tax implications.

Understanding Military COLA

Military COLA is a supplemental allowance provided to service members to offset elevated non-housing expenses in specific high-cost locations. This allowance differs from basic pay, which is a service member’s regular salary. Its primary objective is to prevent financial hardship for service members assigned to areas where everyday goods and services are more expensive than the national average.

The amount of COLA a service member receives can vary based on several factors, including their duty location, rank, years of service, and the number of dependents. It is specifically calculated to address disparities in the cost of living, ensuring that a service member’s income goes as far as it would in a lower-cost area. This allowance helps to ensure that military families do not face undue financial burdens due to their assigned station.

Federal Taxability of Military COLA

The federal income tax treatment of Military COLA depends on the service member’s assigned location, specifically whether they are stationed within or outside the continental United States. The Internal Revenue Service (IRS) provides guidance on this matter in IRS Publication 3.

For service members stationed overseas, known as Outside Continental United States (OCONUS) COLA, the allowance is generally not subject to federal income tax. This tax exemption is a long-standing provision that recognizes the unique financial circumstances of serving abroad. OCONUS COLA is designed to offset the higher prices of non-housing goods and services in foreign locations, equalizing purchasing power with those stationed in the contiguous United States.

Conversely, the Cost of Living Allowance provided to service members stationed within the Continental United States (CONUS COLA) is considered taxable income for federal purposes. This allowance is specifically for those assigned to high-cost areas stateside, defined as locations where the non-housing cost of living exceeds a certain threshold.

State Taxability of Military COLA

State income tax laws regarding Military COLA differ significantly from federal rules. While federal tax rules apply uniformly across the nation, each state has its own set of regulations concerning the taxation of military income and allowances.

Some states may fully or partially exempt military pay and allowances, including COLA, from state income tax. Other states may follow the federal treatment, taxing CONUS COLA but exempting OCONUS COLA. A service member’s state of legal residence also plays a significant role in determining their state tax obligations, as they typically pay taxes to their home state rather than the state where they are temporarily stationed due to military orders. It is advisable for service members to consult their specific state’s tax department or a tax professional to understand their individual state tax liability.

Reporting Military COLA on Tax Forms

The way Military COLA is reported on tax forms depends directly on its taxability. For OCONUS COLA, which is generally non-taxable, the amounts received are typically not included in the taxable wages reported on a service member’s Form W-2.

In contrast, for CONUS COLA, which is considered taxable income for federal purposes, the amounts are usually included in the taxable wages reported in Box 1 of the Form W-2. If there are discrepancies between a service member’s Leave and Earnings Statement (LES) and their W-2, it is important to contact the Defense Finance and Accounting Service (DFAS) or a finance office for clarification.