Paid time off (PTO) is one of the employee benefits that employees value most. The pandemic, however, upset many employees’ PTO plans due to travel restrictions and the cancellation of trips and family gatherings. It has also raised numerous questions among employers around the issues of unused PTO, PTO donation, PTO use during furloughs, and unlimited PTO programs. This article provides some thoughts on these issues as well as the compliance traps employers will want to watch out for.
What can employees do with unused PTO?
In light of the large amounts of unused PTO remaining at the end of 2020, here are some options employers can consider and the relevant compliance considerations:
- Rollover policies. Many employers allow PTO rollovers, but with a cap on the amount of PTO an employee can roll over. Heading into 2021, many employers are temporarily increasing or eliminating the cap altogether, allowing carryover of 100% of the unused PTO. Employers should be consistent among employees when making exceptions to their regular PTO policies to avoid concerns about discrimination or unfair treatment.
- Cash outs. Employers who do not want to permit (or extend) PTO rollovers but also do not want their employees to “lose out” on the value of their unused PTO can consider returning the hours as taxable cash wages. To avoid negative tax consequences under the Internal Revenue Code (IRC), employers should not give employees a choice of whether or not to receive the unused PTO in cash unless that choice is made pursuant to a cafeteria plan. A one-time decision to cash out unused PTO is administratively easiest for the employer if the employer decides to do it unilaterally – that is, without employee choice.
- Benefit transfers. Instead of a cash-out, employers can consider using unused PTO to help fund other employee benefits, such as health insurance, retirement plans, student loan repayments, and/or short-term disability programs. To ensure the proper tax treatment of the PTO upon conversion, any PTO conversion program must be thoroughly vetted by the organization’s tax advisor.
In 2020, we have received more questions than ever from employers asking if employees can donate PTO and how it works. Employees certainly can donate PTO to other employees and even to charities if the employer agrees. The catch, however, is the tax consequences. Unless a PTO donation program is narrowly tailored, the donated PTO is taxable to the donor, which can be administratively burdensome for the employer. Most employers would prefer that the donated PTO be taxable to the recipient (in the case of a donation to an employee). Fortunately, the IRS has provided guidance to employers that allows them to avoid taxing PTO to the donor as long as the PTO donation program is designed to fit one or more of the following categories:
- Medical Emergencies. Unused PTO donated for a medical emergency is not taxable to the donor, but to the recipient. A medical emergency PTO program allows employees to contribute unused PTO to help provide additional PTO for employees who have already exhausted all available paid time off due to a prolonged absence for a medical condition, to care for a family member with a medical condition, or the death of a family member. A medical emergency PTO donation program can be designed to allow employees to contribute to a general bank, from which employees in need can request additional PTO, or it can be designed so that employees can choose specific recipients.
- Federally-declared disasters. . Unused PTO donated for a federally-declared disaster is also not taxable to the donor, but to the recipient. Unlike medical emergency PTO, a disaster PTO donation program cannot allow a PTO donor to choose a specific PTO recipient. While COVID-19 is considered a major disaster, various other requirements apply – be sure to consult with your tax adviser before implementing.
- IRS-declared exceptions. The IRS occasionally has agreed to allow PTO to be donated to certain charitable organizations following national emergencies, without the PTO being taxable to the donor. The most recent exception relates to the COVID-19 pandemic. Employers that wish to allow their employees to donate unused PTO to charitable organizations in 2020 will have the following tax consequences:
- The donations will not be considered income to the employee it if the payments were made before January 1, 2021, and do not need to be included in Box 1, 3, or 5 of the employee’s Form W-2.
- Employers will be permitted to deduct the contributions either as charitable contributions or as trade or business expenses if applicable requirements are met.
- Employees are not able to deduct the value of the donated leave on their income tax returns.
Consult with your tax adviser before implementing any PTO donation program.
Inquiries about unlimited PTO programs have typically come from employers in the professional sectors – engineering, accounting, marketing, consulting, etc. – as well as other employers considering this benefit for exempt (salaried) staff.
“Unlimited” PTO is a misnomer because employers do retain the right to deny PTO for business reasons and to limit PTO in situations where too much time off is impacting an employee’s productivity and job success. Contrary to many employer concerns, studies indicate that employees actually take less time off under an unlimited PTO program than traditional PTO.
Employers wishing to explore an unlimited PTO program must consider the following:
- Procedures for PTO requests and approval;
- Whether or not employees may work at another job when taking PTO;
- How to manage performance and time off if an employee’s performance is suffering due to excessive PTO;
- State laws that may require pay out of PTO upon termination – some states have even issues guidance specifically on unlimited PTO programs; and
- How PTO will coordinate with other leave programs, such as the Family and Medical Leave Act (FMLA)
Please contact our team with any questions about paid leave. Also, for employers in our industries, we can help with navigating the compliance and administrative challenges of PTO policy and much more. Learn more about our association today.