Rev. Rul. 73-187

The Internal Revenue Service has been asked to explain further the applicability of circumstance (3), "Pay for accrued leave," contained in Revenue Ruling 71-343, 1971-2 C.B. 92, for purposes of the exclusion from gross income provided by section 112 of the Internal Revenue Code of 1954 in the case of the payment for accrued leave to a member of the Armed Forces at the time of discharge from the service.

Revenue Ruling 71-343 holds, with respect to circumstance (3), that payments attributable to leave earned by a member of the Armed Forces during any month in any part of which the member served in a combat zone are part of the compensation for active service excludable from gross income to the extent allowed by section 112 of the Code.

Section 112 of the Code provides, in part, for an exclusion from gross income of compensation received for active service as a member in the Armed Forces of the United States for any month during any part of which such member served in a combat zone. The Code section permits the total exclusion of such compensation paid to a member below the grade of commissioned officer, but limits the exclusion to $500 a month of such compensation with respect to a commissioned officer.

With exceptions not relevant to the present question, a member of the Armed Forces is entitled to two and one-half calendar days of leave for each month of active service. (10 U.S.C. 701.) When not used during the month earned, this leave may be accrued and the accumulated leave used, with certain limitations, at a later time while the individual is still a member of the Armed Forces. Use of such leave, whenever used, neither increases nor decreases the individual member's total amount of compensation received for active service in the Armed Forces which would be paid and included in his gross income if, instead, no leave had been used by him.

However, at the time of discharge, members of the Armed Forces who have accumulated unused leave are entitled to be paid a money amount for up to 60 days of such leave. (37 U.S.C. 501(b) and 501(f).) Such unused leave for which payment is made is not, in and of itself, to be considered service for any purpose. (37 U.S.C. 501(c).) Hence, it cannot extend the period of the individual's service nor be a basis for an entitlement to further leave.

Although the use of leave by a member of the Armed Forces decreases his obligation to be present and perform services at his duty station, this does not ordinarily result in the realization of gross income to him; that is, a taxable amount in addition to his base pay or other forms of taxable compensation. The latter are affected neither by the accrual nor the use of such leave. On the other hand, the payment for accrued unused leave to a member of the Armed Forces at the time of his discharge is a monetary compensation in addition to other forms of compensation and is generally includible as such in his gross income under section 61 of the Code.

Accordingly, it is held that since rights to leave accrue by reason of active service, if payments for unused accrued leave made at the time of discharge from the service are designated, pursuant to consistent and appropriate rules, by the Department of Defense as being attributable to unused leave accrued during a period of active service for a month or months during any part of each of which a member in the Armed Forces of the United States served in a combat zone, first, in the case of a member below the grade of commissioned officer, such payments are excludable from his gross income, and second, in the case of a commissioned officer, such payments are excludable from his gross income to the extent that the limited exclusion provided by section 112(b) of the Code has not been previously exhausted by exclusions from income under the same section relating to the same period of service. Of course, under section 112(d) of the Code, to the extent the payment for unused leave of an officer is attributable to leave accrued for any month during any part of which he was in a missing status during the Vietnam conflict as a result of such conflict, the exclusion is not limited.

It is further held that the use of leave by a member of the Armed Forces is irrelevant to the application of section 112 of the Code except for the purpose of determining the extent to which an amount paid for unused accrued leave is attributable to active service in a combat zone.

Circumstance (3) in Revenue Ruling 71-343 is hereby amplified.