Hardship allowances paid to employees are not tax protected. Hardship allowances are payment differentials made to employees who work in foreign countries in which the working conditions are difficult. Employers may give a hardship allowance to an employee if there is a substantial negative difference between the foreign working conditions and the working conditions to which the employee is accustomed.
Hardship Allowance Purpose
Hardship payment differentials are an increase in compensation from the employer. The purpose is to compensate the employee for working in tough conditions, such as hostile country or an area prone to excessive heat or cold. Hardship allowances should not be confused with hazard pay or hazardous duty pay. Hazard pay is an increase in compensation made to an employee who is working in a dangerous area, such as a war zone.
Hardship Allowance Taxes
Employers must report hardship allowances on their employees' W-2 forms for tax reporting purposes. The IRS views hardship allowances as additional wages or salaries, and the income is therefore taxable. The tax rate for this allowance is generally the employee’s regular income tax rate.
Income Tax Consequences
Employers pay hardship allowances in increments of 5 percentage points of the employee’s regular pay. Hardship allowances typically range from 15 percent to 35 percent of the employees regular pay. Depending on how much the allowance increases the employee’s income, it could result in the employee moving to a higher income bracket based on his earnings. This may result in paying a higher amount of income taxes.
Considerations
Employees should consult with their employer to make sure they are being paid a hardship allowance and not a different type of allowance. Many other types of allowances paid to employees working overseas are protected from federal income taxes. Payments not included as a part of the employee’s taxable income and therefore not taxable include cost-of-living, utility bills, food, living quarters, separate maintenance, education and foreign transfer.
