Let’s discuss a situation that’s somewhat common among employers. You have an employee, Sharon, who has used all of her allowed paid time off (vacation, personal, sick, etc.) for the year. Sharon’s mother falls ill with a serious medical condition and Sharon needs to take additional time off work to help care for her mother, but she doesn’t have any paid time off available. Sharon’s coworker, Kim, has a lot of accrued paid time off with no vacation plans so she asks you if she can donate some of her available paid time off balance to Sharon to be able to use during her absence so that Sharon doesn’t have to take unpaid time off work to care for her mother. Can you allow Kim to donate her paid time off to Sharon?
You can. But it’s not that simple.
There is tax law that requires that employees who earn paid time off and have the option to either use it or donate it are responsible for paying taxes on the earnings regardless of whether they use the paid time off or donate it. This means that if an employee donates their earned paid time off to a coworker, both employees would be taxed on the wages.
The IRS allows for two types of exceptions to this rule. In both of these exceptions, the donor is NOT liable for taxes on any paid time off donated (but the recipient of the donated paid time off does still pay taxes on the wages they are paid for the received paid time off). These two exceptions are defined as follows:
- Medical emergency exception – “a medical condition of the employee or a family member that will require the prolonged/extended absence of the employee from duty and will result in a substantial loss of income to the employee due to the exhaustion of all paid leave available, apart from the leave-sharing plan”
- Major disaster exception – a disaster declared by the president of the United States (for example, Hurricane Katrina)
For each type of exception there are certain requirements, like having a written policy for leave donation, in order to be considered a “bona-fide employer-sponsored leave sharing arrangement” by the IRS. For the medical emergency exception, your policy should clearly describe how the donation pool will be structured, what situations will qualify for a medical emergency leave (usually this would be a serious illness of the employee or an immediate family member or the death of a spouse, child or parent), any limits on the amount of leave that can be donated or received, and the procedure by which employees should request to use medical emergency donated leave. It’s important to note that if a plan allows for payment in lieu of time off, it generally will not be considered a “bona-fide employer-sponsored leave sharing arrangement” under IRS rules. For detailed information about the IRS requirements, click here.
To prevent donor employees from being responsible for paying taxes on paid time off donated under a major disaster plan, there are also certain criteria required by the IRS to be included in the employer’s written policy. For example, the employee donating the leave cannot specify which employee will receive the donated paid time off, the employer should establish limits as to how much leave can be donated and how much can be used based on the circumstances of the disaster, and the amount donated in the pool can only be used for the same disaster. For specific criteria from the IRS related to the major disaster exception, click here.
If you do not have a plan established with the IRS requirements, you must withhold taxes for both the donor employee and the recipient of the donated paid time off. You would also be responsible for paying employer paid taxes (such as federal unemployment tax and FICA taxes) on the wages to both employees.
There are a number of additional questions you will need to answer when establishing your policy, such as:
- Who is eligible to donate? All employees? Only after a certain length of employment? Only non-exempt employees? All employees except executives? (It’s important to note that if you exclude any class of employees such as exempt employees or executives there needs to be a business reason that can be proven behind the exemption so the policy is not deemed discriminatory toward a protected class of individuals)
- Who is eligible to receive donations? Similar questions to above – can all employees receive donated paid time off? Only after a certain length of employment? Only a certain class of employee?
- Is there a minimum or maximum amount that can be donated or used? Do donations need to occur in certain increments (i.e., 1 hour, 4 hours, 8 hours, etc)?
Some additional things to keep in mind when creating your policy:
- Payroll Costs. If an employee who makes $12 per hour donates paid time off and an employee who makes $18 per hour uses the donated leave there is an additional cost to the company of $5 per hour paid above their usual payroll expenses. Also, implementing a leave donation program may reduce any forfeited unused paid time off (if you have a “use it or lose it” type paid time off policy and if your state allows this type of paid time off policy).
- Don’t discriminate. The policy needs to be fairly applied to all employees within the organization (unless certain classes of employees are listed as exempt in the policy such as exempt employees or executives who are excluded from the policy for a business related reason).
While creating and implementing the policy may be a bit burdensome, allowing leave donation can increase employee morale and satisfaction within your organization and can help decrease absenteeism overall.
If you decide to establish a leave donation policy, it is advised that you consult a legal and/.or tax professional prior to implementing the policy. You may also want to check applicable state or local tax laws to be sure you are in compliance.