Tax Considerations in Implementing Donated Leave Policies

Source: Peter Alward¸ Partner¸ EisnerAmper LLP¸ 14th January 2013

In light of recent natural disasters¸ employers may be looking for additional low cost programs to assist employees affected by such events.  “Donated leave¸” “leave-sharing¸” or “voluntary shared leave” programs or policies are an employee benefit that employers may offer to their employees.  Generally¸ a donated leave program allows an employee to donate accrued hours of paid vacation¸ personal¸ or sick leave for the benefit of other employees who need more leave than they may have available.  However¸ an employee’s good intentions may have negative unintended consequences.

Little guidance has been issued by the Internal Revenue Service (‘IRS’) with respect to the implementation and operation of donated leave programs.  Employers interested in establishing such a program should be aware that unless their donated leave program meets certain specific requirements the tax implications of such a program could be confusing and unexpected for employees.

General Tax Rules

Federal tax law provides that income for services is taxed to the person who earned it. Accordingly¸ if Employee A earns $500 for his work during a specific week¸ he will be taxed on that $500.  Alternatively¸ if Employee A requests that his employer instead pay the $500 directly to his co-worker instead of to him¸ tax law dictates that even though Employee A never received the $500 he earned¸ the $500 is still taxable to Employee A.

The same rule applies if¸ instead of transferring the $500 directly to the co-worker¸ Employee A decides to donate his earned paid time off (‘PTO’) to his co-worker.  Consequently¸ if the co-worker is sick for an extended period of time and has exhausted her PTO¸ and Employee A tells her “I have extra PTO¸ just use mine¸” under general tax principles any pay that the co-worker receives from using Employee A’s PTO will be taxable to Employee A¸ not the co-worker who received the extra time.

Exceptions to the General Tax Rules

There are exceptions to these general rules.  The IRS offers exceptions for employer-sponsored¸ leave-donation programs.  The first exception allows for “bona fide leave-sharing arrangements” for medical emergencies¸ while the second exception covers leave banks for natural disasters. Leave donated under circumstances that do not meet the requirements of either of these two exceptions will ordinarily be taxed to the employee donating the leave and will also be considered the donor employee’s wages for employment tax purposes.

Medical Emergencies Exception

An employer-sponsored leave-sharing program may permit an employee to donate unused paid leave to another employee in the event of a medical emergency.  Under IRS Revenue Ruling 90-29¸ a medical emergency is