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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.
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:
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:
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.
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:
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:
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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