Clients routinely ask how to get “creative” with accrued paid time off (PTO) banks. In an earlier blog post, I wrote about the ability (or rather, the inability) of employees to have the unrestricted right to cash out PTO. Unfortunately, since I wrote that blog in 2020, the IRS has not budged on the constructive receipt rules applicable to PTO cash outs.
An alternative to a PTO cash out is a leave-donation program. A leave donation program allows employees to donate accrued PTO to a general leave bank, which can then be used by fellow employees who have exhausted all paid leave available to them. PTO donation arrangements are employee-friendly programs that benefit both the sponsoring employer by getting accrued PTO off their books (a nice alternative to a “use it or lose it” rule, which may require employees to forfeit unused PTO), while creating an opportunity for employees to help their fellow employees.
Leave donation programs are simple in concept; however, many employers miss some of the program nuances that serve to prevent negative tax consequences to the donor. Generally, any leave donated by one employee to another would result in taxable income to both parties. The IRS allows two exceptions – leave used for either a “medical emergency” or by an employee impacted by a “major disaster.” (Both of these are terms defined in IRS guidance.) If leave is donated for either situation, there is no adverse tax consequence to the donor. Note the recipient employee will always be taxed on the value of the leave received.
While federal law allows employees to donate either sick leave or vacation pay to be used as paid time off, state laws applicable to sick leave can be complicated and differ from state-to-state, and even from city/municipality-to-city/municipality. These laws are intended to ensure each individual has sufficient sick time during the year. Therefore, creating an employer program that may result in an employee not having sufficient sick time should only be implemented after careful consideration of the application of state and local laws. Additionally, some states consider sick leave as a creature of contract between the employee and employer. In those states, it would likely be permissible for an employee to voluntarily donate sick leave, subject to written direction/consent by the employee. But even if state law would permit donation of sick time, there may be cities/municipalities within that state with different rules. It is therefore important to review state and local sick leave laws in the applicable states/jurisdictions if an employer decides to permit sick leave donation. Alternatively, to avoid entanglements with state sick leave rules, employers may consider a program permitting employees to only donate vacation time. Keep in mind, however, that there are other state laws that view vacation as wages that cannot be forfeited. Accordingly, an employer in one of these states will want to carefully document (in writing) that the employee has voluntarily agreed to the donation after full disclosure of the implications of the donation.
Employers interested in permitting leave donation should adopt a formal arrangement that complies with the IRS’s specific requirements applicable to such programs. The adopting employer should obtain written consent and authorization from employees interesting in donating PTO, and the leave donation program should be structured in a manner that is not discriminatory. The employer should never permit a leave recipient the ability to convert leave received under the arrangement into cash. Finally, the leave program should address what happens when an employee contributes leave at one pay level, and then an employee uses that leave at a different pay level.
While leave donation programs are very well intended, they are complex, with many design issues to consider before a policy is formally adopted. An employee who benefits from a leave donation program will surely remember the employer well, but an employer establishing such an arrangement should take the time to protect the interests of all involved.
