One of your team members hands you a set of military orders. They are in the Guard or Reserve, and they will be gone for two weeks of annual training. Or maybe longer. Your payroll lead asks a simple question: do we keep paying them while they are gone?

The short answer surprises most employers. Federal law does not make you pay an employee while they serve. The job is protected. The paycheck is not. That gap is where a lot of HR teams get confused, and it is where a smart pay policy can set you apart.

This guide breaks down what you are actually required to do, what military differential pay is, why many employers offer it anyway, how it gets taxed, and which state and local rules can change the math. If you hire Guard and Reserve members, this is the policy question you will face sooner or later.

Do Employers Have to Pay Employees on Military Leave?

No. Private employers are generally not required by federal law to pay employees during military leave. The leave itself is unpaid unless you choose to pay it.

The law that governs this is the Uniformed Services Employment and Reemployment Rights Act (USERRA). USERRA protects a service member's job. It does not require a paycheck during the absence.

Here is what USERRA actually does. It guarantees that a returning service member gets their old job back, or one close to it, with the same seniority, status, and benefits they would have earned. It protects against discrimination based on military service. It sets a five-year cumulative limit on how long someone can be away for military duty and still keep these rights.

The Department of Labor is direct about pay. Many employers choose to provide all or part of an employee's pay during military service. There is no obligation under USERRA to do so.

So the baseline is clear. You must hold the job. You do not have to fund the absence. But "you do not have to" is not the same as "you should not." A lot of strong employers pay anyway, and they have good reasons.

What Is Military Differential Pay?

Military differential pay is when an employer covers the gap between an employee's military pay and their civilian pay during military leave.

It works like this. Say an employee earns $1,500 a week at your company. They get called to active duty and their military pay comes to $900 a week. The difference is $600. With a differential pay policy, you pay that $600 gap so the employee does not lose income while they serve.

Differential pay is not full salary on top of military pay. It is a top-up. The goal is to make the employee whole, not to pay them twice. Most policies cap the benefit at a set number of days per year or per period of service.

Differential pay sits in the middle. It is more generous than nothing. It costs less than full pay. For a midsize company that wants to support Guard and Reserve employees without breaking payroll, it is the most common middle path.

Why Do Employers Offer Differential Pay If They Don't Have To?

If the law does not require it, why do so many companies pay? Because the return on a small payout is large. Here is what a differential pay policy buys you.

It keeps good people from leaving

Guard and Reserve members are some of the most reliable employees you can hire. They show up. They lead. They handle pressure. Losing one because they could not afford to serve is an expensive mistake. A differential pay policy removes the financial penalty for serving, so they stay.

It builds a reputation that recruits for you

Word travels fast in the military community. A company known for taking care of its Guard and Reserve members earns trust before the first interview. That reputation pulls in more veteran applicants, which lowers your cost to fill skilled roles.

It signals stability to your whole team

When employees see you support someone through a deployment, they read it as a sign of how you treat people. That goodwill is hard to buy and easy to lose. A clear, fair military leave policy is one of the cheapest culture investments you can make.

For the deeper retention playbook, see our guide on how to train managers to retain your veteran hires. Pay policy is one piece. How your managers handle the absence is the rest.

How Is Military Differential Pay Taxed?

This is where payroll teams need to be careful. Military differential pay has its own tax rules, and they are not what most people expect.

The IRS treats differential wage payments as wages for income tax purposes. So they are subject to federal income tax withholding. You report them on the employee's Form W-2 in Box 1.

But there is a key difference. Differential wage payments are not subject to Social Security tax, Medicare tax, or federal unemployment tax. So they do not go in the Social Security or Medicare wage boxes on the W-2. Income tax yes. FICA no.

That split trips up payroll systems that treat every payment as standard wages. If your system pulls Social Security and Medicare on differential pay, you are over-withholding. Set it up right from the start.

There is a federal tax credit for differential pay

Paying differential wages can earn you a federal income tax credit. It is found at 26 U.S. Code Section 45P, the employer wage credit for active-duty members of the uniformed services.

The credit equals 20 percent of the eligible differential wage payments you make to a qualified employee. The payments that count are capped at $20,000 per employee per year. So the most this credit returns is $4,000 per qualified employee in a year.

A qualified employee is someone who worked for you for the 91 days right before the differential pay period starts. The credit is claimed on IRS Form 8932. It is one of several ways to offset the cost of hiring and keeping veterans, which we cover in our guide to veteran hiring incentives beyond WOTC.

One point that confuses people. The credit started as a small-employer-only benefit. A 2015 law change removed that limit. Since tax years after 2015, employers of any size can claim the credit. Confirm the current rules with your tax advisor or the IRS before you file, because tax provisions shift.

Do Any States or Cities Require Paid Military Leave?

Yes. Federal law sets the floor, not the ceiling. Some states require paid military leave for public-sector workers. A few local laws reach private employers too.

The one that gets the most attention is San Francisco. Its Military Leave Pay Protection Act took effect in February 2023. It was the first major city law to require private employers to provide paid military leave.

Under the San Francisco ordinance, private employers with 100 or more employees must provide supplemental compensation during qualifying military leave. The supplemental pay covers the difference between the employee's military pay and the gross pay they would have earned at work. The benefit runs up to 30 days in a calendar year. It applies to employees who work within San Francisco, including part-time and temporary workers.

If you have any workforce in San Francisco and 100 or more employees total, this likely applies to you. Local rules change and get updated, so confirm the current text and thresholds before you build your policy around them.

The takeaway for a multi-state employer is simple. USERRA is the federal baseline everywhere. On top of it, state and local rules can add paid-leave duties you do not get to skip. Map your obligations by location before you write the policy.

How Should a Midsize Employer Set a Military Leave Pay Policy?

You do not need a Fortune 500 program to do this well. A clear, written policy that your payroll and managers understand beats a generous policy nobody can apply. Here is how to build one.

Two more things make the policy work in practice. First, keep benefits running during the leave where you can, since USERRA already protects continued benefit rights. Second, plan the return early. The reemployment piece is where employers most often slip up, and it is the part the law watches closest. Our guide on managing an employee called to active duty walks through the full process.

For the full set of duties around hiring and holding Guard and Reserve members, read our USERRA employer obligations guide and our broader walkthrough on hiring National Guard and Reserve members. If you want help and recognition for the effort, the ESGR program exists to support employers who back their service members.

The Bottom Line for Employers

You are not required to pay employees on military leave. USERRA protects the job, the benefits, and the right to come back. The paycheck during the absence is your call.

But the math favors paying. Differential pay is a low cost with a high return. It keeps skilled Guard and Reserve members on your team. It earns a reputation that pulls veteran talent toward you. And it may qualify for a federal tax credit on top. Beyond the federal floor, watch for state and local rules like San Francisco's that can turn the choice into a requirement.

If you want differential pay to be a hiring advantage and not just a line item, you need a steady flow of Guard, Reserve, and veteran candidates to apply it to. That is where we come in. Best Military Resume adds over 1,000 new veteran and military-spouse profiles every month and has built more than 60,000 resumes. These are people who already match the kind of skilled, reliable talent a smart military leave policy is built to keep.

Want access to that talent pool? Reach out about hiring veterans through BMR and put your military leave policy to work on the people it was made for.