Surveys have shown some employees want more vacation benefits, whereas other employees prefer more cash options. A vacation buy/sell program through a cafeteria plan provides employees the flexibility to choose the benefits they desire and employers an easy vehicle to meet employee needs. Depending on plan design, a plan can allow employees who want more time off to purchase additional paid time-off (PTO) days either through employer flex credits or salary reductions. Or employees may choose to receive cash or use flex credits toward other nontaxable benefits offered under the cafeteria plan, such as major medical, health flexible spending account (FSA), or dependent care assistance plan (DCAP) benefits.
A cafeteria plan may permit PTO buying, PTO selling or both. However, 2007 proposed regulations from the Internal Revenue Service (IRS) impose some limitations that employers will need to consider with its overall vacation strategy if the plan is to strictly follow the proposed regulations. Note that the 2007 proposed regulations are for guidance purposes and are not used for enforcement purposes.
Under the 2007 Proposed Regulations, unused “elective” PTO days (i.e., days that are purchased or can be sold under the cafeteria plan) must be cashed out or forfeited by the plan’s year-end. The regulations do not permit elective PTO to be carried over from one plan year to the next.
Employers may deem that a cash-out feature meets their vacation strategy. Strategy considerations include allowing employees the flexibility to buy and sell to accommodate vacation plans that can change over the course of an entire plan year; designing the plan to support employees who get sick and need PTO while still rewarding those who do not use it by buying back unused time; or encouraging cash-out of unused PTO to be applied to other benefits areas, such as their retirement accounts. Finally, having the possibility of getting extra pay at the end of the year and of not risking forfeiture of vacation or cash benefits encourages employees to use the benefit.
When using a cash-out strategy, some employers reimburse sold PTO days on a dollar-for-dollar basis, whereas others apply a reduced rate (e.g., 50 cents on the dollar). Also consider how cash-out values will be determined for pay out—at the original purchase rate or based on the employee’s compensation when the cash-out occurs.
The regulations require that cash-outs must be received by participants on or before the last day of the plan year and be treated as taxable income; forfeitures must be effective as of the last day of the plan year; and the grace period does not apply to PTO buying and selling.
Conversely, employers may prefer forfeiture to encourage employees to take PTO or to avoid year-end payments. The unanticipated outcome, however, could result in scheduling concerns (days away at a critical time of year) or result in noncompliance with state vacation laws.
The proposed regulations also establish an “ordering rule” that applies when PTO buying or selling is offered under the plan. Under the rule, nonelective PTO days (i.e., regular PTO accruals not offered or elected through the cafeteria plan) must be used before elective PTO days.
The “order rule” will have an effect on cash-out and carry-over policies. A situation in which the employer’s plan does not provide a cash-out option at year-end, because the proposed regulations impose the order rule and preclude the option for carry-over of elected PTO, without the cash-out option, will require forfeiture of any elective days. If the plan does provide a cash-out option at year-end, the employer will want to consider whether it will permit carry-over of nonelective PTO and therefore payout of all elective PTO.
The buy/sell feature is an option for providing benefits that employees want. However, employers cannot establish a cafeteria plan that only offers the choice of cash or PTO; under the regulations, this is not a cafeteria plan. A cafeteria plan must offer pretax qualified benefits to be considered a plan. When considering whether to provide PTO buy/sell features, the employer must consider if ordering and cash-out/forfeiture rules will fit with the overall vacation/PTO strategy.
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