Hurricane Sandy highlighted the role of programs that allow employees to donate the value of their unused paid time off (PTO) from work or share it with fellow employees. Following are the main types of programs and their tax treatment.
Standard PTO Charitable Donation Programs
In this type of program, employees may donate the value of their unused or unwanted PTO to a charitable organization. The employer typically pays the organization cash equal to the value of the donated PTO, which the donating employee generally must recognize as taxable compensation income that is subject to income tax and FICA withholding. The amount the employer withholds must be deducted from the employee’s wages, which will reduce the employee’s paycheck in the pay period the donation is made. To avoid reducing the employee’s paycheck, the employer may “gross up” the employee’s pay so that the employee’s after-tax pay is not reduced, or the employer may reduce the donation by the amount required to be withheld. Because the value of the PTO is donated to a charitable organization, the donor employee is allowed a charitable contribution deduction under Sec. 170. The employer is allowed a deduction for the value of the donation as compensation expense under Sec. 162.
Disaster Relief PTO Charitable Donation Programs
In certain situations, the IRS has allowed employees to avoid recognizing the value of PTO donated to a charitable organization as compensation income. The most recent of these situations was in the aftermath of Hurricane Sandy. In Notice 2012-69, the IRS provided that employees who donate unused PTO under a program in which the employer contributes the value of the PTO before Jan. 1, 2014, to a Sec. 170(c) charitable organization for the relief of victims of Hurricane Sandy will not be required to recognize compensation income for the value of the donated PTO. Because the employee does not include the value of the donated PTO in income, he or she is not allowed to take a charitable contribution deduction. The IRS will not assert that the employer will be permitted to deduct the cash payments only under Sec. 170 as a charitable deduction but will allow the employer to deduct the payments as compensation under Sec. 162. Previously, the IRS authorized disaster relief PTO programs in response to Hurricane Katrina (Notice 2005-68), and the Sept. 11, 2001, terrorist attacks (Notice 2001-69).
Standard Leave-Sharing Banks
In another type of program, an employee surrenders an amount of unused accrued PTO that the employer places in a leave-sharing bank. Other employees who have run out of PTO can then draw on the bank for reasons specified by the employer. As with the standard PTO charitable donation program, the employee who surrenders the PTO is required to recognize taxable compensation income equal to the value of the surrendered PTO, unless the arrangement qualifies as one of the two types of leave-sharing plans discussed below. The donating employee is not entitled to a charitable contribution deduction because he or she does not make a contribution to a charitable organization.
Major Disaster Leave-Sharing Plans
In a major disaster leave-sharing plan, PTO surrendered by an employee to the plan is only available to employees adversely affected by any presidentially declared major disaster. If the plan is in writing and meets certain conditions in Notice 2006-59, the donating employee is not required to recognize compensation income and is not allowed a charitable contribution deduction.
The employer may take a compensation deduction under Sec. 162 when payments are made to recipients from the plan, not when the PTO is surrendered to the plan. Recipients of payments from the plan must include them in income, and the employer must treat the payments as compensation and withhold the appropriate income and FICA taxes.
Medical Emergency Leave-Sharing Plan
In a medical emergency leave-sharing plan, PTO an employee surrenders to the plan is available only to employees with medical emergencies. For this purpose, a “medical emergency” is a medical condition of the employee or a family member of the employee that will require the prolonged absence of the employee from duty and will result in a substantial loss of income to the employee because the employee will have exhausted all PTO available apart from the leave-sharing plan. In Letter Ruling 200720017, the IRS approved a plan in which a prolonged absence included intermittent absences related to the same condition or illness. In Rev. Rul. 90-29, the IRS ruled that as long as certain conditions are met, an employee who donates PTO to a medical emergency leave-sharing plan is not required to recognize compensation income for the value of the donated PTO and is not allowed to take a charitable contribution deduction.
The employer may take a compensation deduction under Sec. 162 when payments are made to recipients from the plan, not when the PTO is surrendered to the plan.
Recipients of payments from the plan must include them in income, and the employer must treat the payments as compensation and withhold the appropriate income and FICA taxes.
Outweighing the Burdens
Employers that establish a PTO charitable donation or leave-sharing program can thereby enable their employees to share in relieving hardship, as companies demonstrate their concern for their own employees experiencing difficulties or for their community or the nation at large when disaster strikes. Although maintaining a compliant tax-favored plan may require extra time and expense of administration, many employers are likely to see the benefits as outweighing the burden.
By Jeffrey A. Martin, CPA and G. Edgar Adkins Jr., CPA, senior manager and partner, respectively, with Grant Thornton LLP, Washington, D.C., FEBRUARY 28, 2013.
Edited and posted by Harold Goedde CPA, CMA, Ph.D. (taxation and accounting)