One of the issues employers are facing during the COVID-19 pandemic is how to handle PTO payouts. Many PTO plans allowed employees to make an election in 2019 to cash out a certain amount of PTO during 2020. These payouts often take place once or twice a year on a set date.
The election is made in the prior year to avoid a tax rule known as constructive receipt. If employees were given the option to either cash-out or rollover unused PTO, the constructive receipt rule would say that the employees have constructively received all of the unused PTO during that year. The result is that the employee is taxed on the full amount of the PTO - including the portion that they chose to roll over to the next year, even though the employee did not actually receive that money.
By having your employees make the election in the prior year before the current year PTO has accrued, this tax issue is avoided and employees are only taxed on the PTO actually taken and the PTO payouts actually received. The PTO that an employee elects to roll over to the next year is not taxed until that PTO is eventually paid some time down the road
Facing a modified set of paid leave rules along with general financial uncertainty, many employers are wondering how to handle PTO payouts in this context. Below are a few common questions we have seen pop up, along with our recommended course of action.
Q: Our employee made an election in 2019 to take a certain amount of PTO as a payout in 2020. Our plan provides for two payout dates - one in May and one in November. Can our employee delay taking their payout until the November date?
A: Yes, so long as the PTO payout is received in 2020, there should not be a constructive receipt issue. The U.S. tax system runs on an annual basis and the PTO would be included in income in 2020 regardless of the payout date. Be sure to obtain written consent from the employee to delay this payment.
Q: Our employee made an election in 2019 to take a certain amount of PTO as a payout in November 2020. What happens if my employee does not have enough remaining PTO in November to facilitate the payout?
A: From a tax perspective, this is not an issue. The election made in 2019 means that the employee must cash out a certain amount of PTO during 2020 if the employee accrues that amount of PTO and if that amount of PTO is actually available for payment. Many employers may find themselves in a situation where an employee has exhausted all PTO hours prior to the payout date. In that case, the employee will be taxed on the PTO when she takes it and this does not create any tax problems.
PTO Payout Examples
Example 1: Jane Employee anticipates accruing 80 hours of PTO during 2020 and made an election on December 15, 2019, to cash out 40 of those anticipated hours on November 1, 2020. Jane uses all 80 of her anticipated PTO hours prior to November 1, 2020. Because Jane utilized all of her PTO hours, there are no PTO hours available for payout on November 1. The fact that she had previously elected to cash out 40 hours does not have any adverse tax effect on her or the employer. Since those hours were not available for cash out, no PTO payout is made on November 1.
Example 2: Jack Employee anticipates accruing 80 hours of PTO during 2020 and makes an election on December 15, 2019, to cash out 40 of those anticipated hours on November 1, 2020. Jack uses 0 of his anticipated PTO hours during 2020. Pursuant to the election, his employer must make a PTO payout of 40 hours on November 1. Jack may use the remainder of his PTO hours during the remainder of 2020 (in which case they will be taxed as wages) or Jack may roll over those hours to be used in a future year, or a combination of the two. The employer cannot pay out the remaining 40 hours as a PTO payout, because the employee has only elected to take a PTO payout of 40 hours, which was previously paid on November 1.
Q: Our company is facing financial uncertainty as a result of COVID-19 and is concerned about our ability to make PTO payouts that were elected in 2019 for PTO hours accrued in 2020. What options do we have?
A: One option would be to suspend the program temporarily until your company can make these payments. An election made in 2019 only applies to PTO hours accrued by your employees in 2020. By suspending the program temporarily, your employees would only have accrued PTO from January 1, 2020, through the date the program is suspended. To avoid negative tax consequences for your employees, you must continue to make PTO payouts for PTO accrued in 2020 for which the employee has made a previous election to take a PTO payout. If the payout is not made, the IRS views the fact that the employer and employee are not following the 2019 election as if the employee is constructively receiving all accrued PTO. The result is that the employee is taxed on the full amount of PTO accrued in 2020 whether the employee actually receives the PTO or not.
Another option would be to obtain written employee consent to make the PTO payouts later in 2020. So long as the elections are followed and PTO payouts are made during 2020, there should be no issues with constructive receipt.
Contact your attorney if you need assistance or if you have any questions about what is allowed under your particular PTO plan.
