Charitable leave-based donation programs provide employees the option of donating leave that can be converted into cash contributions to charities assisting the victims of the novel coronavirus (COVID-19) pandemic.
As the devastating effects of the COVID-19 pandemic continue, individuals and businesses throughout the country are actively seeking opportunities to assist those in need. In response, the Internal Revenue Service (IRS) released Notice 2020-46 on June 11, providing guidance on the tax-favored treatment of charitable leave-based donation programs. The notice follows President Trump’s Emergency Declaration for all 50 states, the District of Columbia, and five US territories under the authority of the Stafford Act on March 13, 2020.
Although charitable leave-based donation programs do not require significant investments of time and resources to establish and administer, few employers have done so due to a lack of knowledge of the programs and/or because such programs only come into relevance in conjunction with infrequent, catastrophic events.
WHAT IS A CHARITABLE LEAVE-BASED DONATION PROGRAM?
A charitable leave-based donation program is an employer-sponsored program that provides employees the option to donate accrued but unused vacation, sick, or personal leave to the employer in exchange for employer contributions to charitable organizations that are providing relief to disaster victims.
Charitable leave-based donation programs are attractive for numerous reasons. Many employees do not have readily expendable resources to donate to relief efforts when disasters occur, and in some cases, employees may wish to donate more than the cash they have available. Accrued leave can be an appealing asset to donate, particularly if the employee does not expect to use the leave.
For example, during the COVID-19 pandemic, many frontline healthcare workers have leave they are unable to use that they may wish to donate. A charitable leave donation program allows employees to convert unused vacation, sick, or personal leave into cash contributions that the employer transfers to charitable organizations assisting victims.
Such programs offer employees a simple method of leave donation. Employees can make charitable donations of leave to the program, and employers can either designate certain charitable organizations to receive the cash value of the donations or allow the employees to pick one or more specific charitable recipients from a list prepared by the employer. The recipients should all be charitable organizations—including national, regional, and faith-based organizations—that are assisting victims of the COVID-19 pandemic.
HOW DOES IT WORK?
In establishing a charitable leave donation program, employers are given latitude to design a program that fits within the employer’s particular needs, circumstances, and policies. At a basic level, the employer must decide who is eligible to participate in the program and what types of leave may be donated. Many employers will allow all employees who are eligible to accrue leave to participate, and will permit any type of leave (including sick leave) to be donated. The employer must also determine in what increments leave can be donated, (i.e., hours, days, weeks).
The employer establishes an open enrollment period after making these basic decisions. During this enrollment period, employees are able to file an election form with the employer to donate accrued leave or to pledge leave that will be accrued in the future.
Once the employee elects an amount of leave either to donate at one time or to pledge over time, the employer will contribute directly to the charitable organization a cash amount equal to the gross amount of the employee’s donated leave. The employer then reduces the employee’s leave balance by a corresponding amount. For example, if the employee is paid $20 per hour and donates eight hours of personal leave, the employer will make a cash donation of $160 to the charitable organization and reduce the employee’s leave balance by eight hours.
WHAT IS THE FAVORABLE TAX IMPACT OF PARTICIPATING IN THE PROGRAM?
With Notice 2020-46, the IRS extended favorable tax treatment to both employers and employees that override traditional tax principles of constructive receipt and assignment of income for contributions made prior to January 1, 2021.
In particular, the IRS will not assert that the employee’s election to donate accrued leave triggers constructive receipt of employee wages. In plain English, employees can effectively donate in a more tax-efficient manner than if they had claimed a charitable deduction because the charitable leave donations are effectively pretax donations. This pretax treatment means that the donations of accrued leave
- are exempt from federal income taxes,
- are exempt from Federal Insurance Contributions Act (FICA) taxes,
- are exempt from alternative minimum tax (AMT), and
- avoid the limitations placed on charitable contributions by those employees who do not file itemized tax returns.
This is a favorable tax tradeoff that more than offsets the fact that the employer, not the employee, is the taxpayer that claims the deduction for the contributions. And the charitable organizations aiding the victims receive a larger cash donation due to the effects of this pretax treatment.
As noted above, employers receive favorable tax treatment from these programs. Although the employees cannot claim a charitable contribution deduction, employers are permitted to elect to deduct the cash payments either as charitable contributions (up to the applicable limitations) or as business expenses to the extent of goodwill advertising. In addition, the employer reduces its FICA tax liability because the donations, as compared to the leave payments, are exempt from FICA taxes.
It is important to note that if the employee donating leave cannot carry over unused leave or receive a “cash-out” for the unused leave, then the employer may bear the financial burden of making the contributions. Such employers can require that the employees donate from otherwise nonforfeitable leave or limit the amount of forfeitable leave that can be donated.
As with only a small number of previous major disasters (e.g., 9-11, Hurricane Katrina, Hurricane Sandy, Hurricane Harvey), the IRS notice adopts a nonenforcement position. In the notice, the IRS confirms that any cash payments made by the employer that represent the donated leave will not be considered gross income or wages to the employee (and are not required to be reported on the employee’s Form W-2) if the payments are made to certain charitable organizations described in Section 170(c) of the Internal Revenue Code. The donations must be made for the relief of victims of the COVID-19 pandemic.