The term is "Combat Zone Tax Exclusion", or CZTE for short. Your Social Security and Medicare will continue to be deducted, as they aren't technically a "tax".
Also, any leave that is earned while in a CZTE area is also tax free. That means that when you decide to take that trip to the Bahamas after you get back from the sandbox, while you are on leave your pay during that time will not be taxed. This type of leave is known as "combat leave".
Here is the kicker: If you spend any portion of a month in a CZTE area, then the ENTIRE month is tax free. My C-130 touched down in Iraq five minutes prior to midnight on the last day of the month. I RAN LIKE HELL to the receiving duty officer (or whatever he called himself), and ensured that he marked me down at 2358. Whew...
Another thing, the same thing applies when you return home. It was obvious that our flight back home was deliberately delayed so that we would leave the first day of the month (which meant that we got that entire month tax free, for only having been in a CZTE for a day.
It gets better: Since we already had that month tax free upon our arrival back in the states, few people wanted to take leave. That is because your combat leave balance is used before your regular leave balance. If we wait until the month after we get back to take leave, then we are able to not double dip, but TRIPLE dip our tax benefit (because the pay accrued while on combat leave is not taxed.
This concludes today's lesson.