How Terminal Leave and Leave Sell-Back Are Taxed (2026)

"Take it or sell it" is the terminal-leave decision, and taxes are a big part of the answer. Taking leave and selling it back are taxed in completely different ways, and one specific rule, the combat-zone exclusion, can let you cash out some of your leave entirely tax-free. Here is how each path works in 2026.

Taking Terminal Leave: Taxed Like a Normal Month

When you take terminal leave, nothing special happens tax-wise. You are on active duty drawing your normal pay:

• Base pay is taxed as ordinary income, withheld monthly like always.
• BAH and BAS stay tax-free — the allowances keep their tax advantage the entire time you are on leave.
• TRICARE continues at no cost.

That tax-free housing and food allowance is a big reason taking leave usually beats selling it: you keep the full, partly-untaxed compensation package right up to your DD-214 date.

Selling Leave Back: Base Pay Only, Taxed as a Lump Sum

Selling leave is a different animal. A few things change at once:

• It pays base pay only. Each sold day is worth 1/30 of your monthly basic pay. No BAH or BAS is included, so a sold day is worth noticeably less than a day of taken leave.
• It is fully taxable wages. The lump sum is treated as supplemental wages and is typically withheld at the flat 22% federal supplemental rate for 2026 (amounts under $1 million). Your actual tax owed depends on your total income for the year, so the withholding may be more or less than your final rate.
• FICA applies. Because sell-back is treated as basic pay, it is subject to Social Security and Medicare taxes.
• State income tax may apply based on your state of legal residence.
• The 60-day career cap. You can sell back a lifetime maximum of 60 days of leave across your entire career (10 U.S.C. § 501). Days taken as terminal leave do not count against this cap.

The Combat-Zone Rule That Saves the Most Money

Here is the detail most people miss. Leave that you accrued during a month you served in a combat zone can be sold back tax-free under the Combat Zone Tax Exclusion (CZTE). When you sell CZTE leave, that portion of the lump sum is excluded from your taxable income.

For enlisted members and warrant officers the exclusion is unlimited; for commissioned officers it is capped at the monthly exclusion limit. The practical strategy: if you have combat-zone leave on the books, selling that leave is the tax-efficient way to cash out, while you take the rest of your leave as terminal leave to keep the allowances. Your finance office tracks which of your leave days are CZTE-eligible.

Putting It Together

For most people the math shakes out like this:

• Take your ordinary leave as terminal leave — you keep tax-free BAH/BAS and can overlap a civilian job for double income.
• Sell any combat-zone leave, because it comes out tax-free and does not benefit from the "keep your allowances" logic.
• Watch the 60-day lifetime cap so you do not plan around selling days you are not allowed to sell.

Run your specific numbers, including the tax drag on sell-back, with the terminal leave calculator. It compares the after-tax value of taking versus selling for your rank and leave balance.

The Bottom Line

Taken terminal leave is taxed like any normal month, and your BAH and BAS stay tax-free. Sold leave is base pay only, taxed as a lump sum at the 22% supplemental rate plus FICA and any state tax, and capped at 60 days over your career. The one exception worth chasing is combat-zone leave, which you can sell tax-free. Confirm your CZTE-eligible days and your exact figures with your finance office before you submit.

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Sources: DoD Financial Management Regulation Vol. 7A (military pay & leave), 10 U.S.C. § 501 — Payment for unused leave (60-day career cap), IRS Publication 3 — Armed Forces' Tax Guide (combat zone exclusion), IRS — Supplemental wages withholding. Figures reflect 2026 rules; confirm your CZTE-eligible days and withholding with your finance office. General information, not tax advice.