HR Topics

 How to Create a Leave Donation Program

 

Sep 6, 2013
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Leave donation or leave sharing programs allow employees to donate accrued paid time off (PTO), vacation or sick leave to a general pool to be used by fellow employees who experience medical emergencies or who are affected by major disasters and have exhausted all paid time off available to them. Leave donation programs may benefit the employer and enhance employee morale and employee camaraderie. These employee-friendly programs may also play a role in increasing productivity, reducing absenteeism, and improving recruiting and retention of quality employees.

Employers must consider several factors before implementing such a program. First, a program must meet specific design characteristics to qualify for Internal Revenue Service (IRS) exceptions so that employee donations are not considered taxable income to the donor. Employers must also decide maximum amounts of leave that may be donated as well as the definition of an “eligible employee” (for example, length of service requirements) to either donate or receive leave. Additionally, employers must develop clear rules that govern an employee’s entitlement to donated PTO or vacation leave.

The IRS has not explicitly defined and addressed all aspects of leave donation programs. However, employers have been provided with some guidelines regarding the required plan design features necessary to qualify for one of the two designated exceptions for either a medical emergency or major disaster. Leave donation programs for medical emergencies are the most prevalent programs.

Step 1. Decide Which Type of Leave Donation Program the Employer Wishes to Implement

Medical emergency exception

The IRS defines a “medical emergency” as 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.” Employees who have exhausted all of their available leave may be able to obtain additional paid time from the pool if they experience a medical emergency or if they should need to care for a spouse, child or parent who experiences a medical emergency.

For a plan to be considered what the IRS characterizes as a “bona-fide employer-sponsored (medical) leave-sharing arrangement,” it should:

  1. Be in writing and be administered by the employer.
  2. Be created as a leave bank or pool for employees to deposit donated leave and from which leave will be distributed to recipients.
  3. Specify that leave is to be used only for medical emergencies. The plan should restrict these medical emergencies to major illnesses or medical conditions of employees or their family members that require extended absences. Under IRS regulations, employer plans may also include extended time off following the loss of a spouse, child or parent.
  4. Outline and specify limits on the amount of leave that may be donated by an individual in any given year.
  5. Have a detailed procedure in place for employees to submit a written request for leave that describes the specific medical emergency or medical condition. Employees should be eligible to receive leave only after their request has been approved and all other available paid leave has been exhausted.
  6. Have processes in place to confirm that all leave transferred under the plan is actually being used for medical leave by the recipient.

A program that allows for the liquidation of leave and that pays out cash to the recipient will likely not be viewed as a qualified plan.

Major disaster exception

Leave from an employer-sponsored leave bank or pool may be taken by an employee who is adversely affected by a major disaster. Under the rules, “major disasters” are defined as a) disasters declared by the president under §401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act (the Stafford Act) or b) a major disaster or emergency declared by the president pursuant to 5 U.S.C., §6391.

Similar to the medical emergency leave sharing programs, to meet the IRS exception major disaster plans must be in writing and must also meet the following requirements:

  1. The amount the donor employee may donate in any given year may not exceed the maximum amount of leave that he or she normally accrues during the year.
  2. The plan does not permit the donor to designate a specific leave recipient.
  3. The plan allows donor employees to deposit accrued leave into an employer-sponsored leave bank, to be used by other employees who are adversely affected by a major disaster. This means that a disaster has caused a severe hardship to the employee or to the employee’s family members and requires that the employee miss work.
  4. The plan places a “reasonable limit” on the period of time after the disaster occurs when leave may be donated and when it must be used. Reasonable limits will be determined by the severity of the disaster.
  5. Employers must make a reasonable need-based determination regarding how much leave each recipient may receive under the plan.
  6. The leave recipient will receive paid leave at his or her normal rate of pay. The leave must be used for the purposes related to the natural disaster.
  7. The leave recipient may not receive cash in lieu of using the paid leave received. However, the recipient may use the leave received to offset an accrued negative leave balance.
  8. Leave deposited for one major disaster may only be used by employees who are directly or indirectly affected by that one disaster. Any leave time remaining unused by the end of the “reasonable limit ” must be returned to the donor employee.

Under both medical emergency plans and major disaster plans, donor employees may not claim an expense, a tax deduction or a charitable contribution for any of the leave donated under the plans. Additionally, all paid leave granted to the recipient employee is considered wages and is subject to Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA) and other required tax withholdings.

Should a plan fail to meet the specified criteria to qualify for an IRS exception, leave donations paid out to a recipient could be considered taxable wages to the donor as well.

Step 2. Decide on the Design Features for the Plan

Program design choices

When implementing a program, employers should ensure that the program design meets the specified criteria to avoid any adverse tax consequences to the donor employees. If proper designs and control requirements are met, the tax liability will be effectively shifted from the donor to the recipient.

Although leave donation plans have many favorable aspects, they may also generate an array of different issues and concerns. Among the issues include possible cash flow or increased PTO use costs, discrimination or favoritism claims from disgruntled employees, administrative challenges, and potential privacy-related issues. Generally speaking, employers will create budgets and cost projections with the expectation that a certain percentage of PTO or vacation time will go unused each year. Therefore, a leave donation program may result in an increase in the use of paid leave that may have been forfeited in years past, thus creating potential cash flow issues and increased payroll expenses.

Employers should analyze the following issues associated with leave donation programs and how they may affect the organization:

  1. An employer may experience an increase in PTO or vacation pay out, even if the total number of hours used each year does not increase. This situation may occur when donations come primarily from lower paid employees and distributions are given to higher paid employees. How will this potential increase affect the organization’s cash flow and its strategic business plan? See, How do employers account for salary differences in donated leave programs?
  2. Tracking leave donations, leave requests, leave distributed and the appropriate pay rate for each distribution, as well as the donated leave that must be returned, could become administratively cumbersome. Does this responsibility require additional head count or an investment in software systems to monitor donations and requests?
  3. Recognizing the possibility that claims of discrimination and unfair treatment may arise should sufficiently convince an employer of the importance of clearly stated, neutral eligibility criteria applied equally across all employee groups. How can the employer best balance transparency and employee confidentiality? What eligibility criteria will be used to ensure equal access to both sides of the process for all employees who wish to participate?

In addition to the IRS design requirements necessary to achieve the desired shift in tax liability under a bona fide leave sharing arrangement, other design characteristics should be carefully considered:

  1. Reasonable limits should be placed on the number of hours of leave an employee may donate to ensure that the donor employee retains a sufficient amount of time to meet his or her own needs. Reasonable limits should also be placed on the amount of leave a recipient may receive within a given period of time. Employers should also consider implementing a reasonable application window within which a request must be submitted (i.e., within 30 or 60 days following the medical emergency or major disaster). Similarly, the employer may also choose to implement a deadline for donating leave in response to a specific major disaster.
  2. Employers should also study how distributions from the leave bank may affect short- or long-term disability (STD/LTD) benefits. Will the receipt of distributions from the leave bank potentially delay STD/LTD benefits, or may the donated leave be used to supplement the disability benefits once the employee has exhausted all of his or her available paid leave?
  3. Employers should also be cognizant of any state regulations that govern what leave may be donated in the states in which they do business. For example, different states have specific rules regarding an employee’s right to various types of leave, whether accrued, earned, unearned, vacation, paid time off or sick. Employers should review these state regulations when contemplating a leave donation plan.

Step 3. Implementation and Roll Out

Finally, employers electing to implement a leave donation or leave sharing program should create and execute a robust communications campaign to ensure that both the employee and employer receive the maximum value from the program. A communication plan should clearly identify qualifying events and circumstances, leave donation and leave request processes, and eligibility criteria for both donors and recipients. A well-designed and effective program may become a valuable tool in building employee morale, enhancing camaraderie, reducing turnover and absenteeism, and positively affecting overall productivity.

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