As the numbers of those affected by COVID-19 continue to climb, the Internal Revenue Service (IRS) is providing guidance for employers whose employees take advantage of leave donation programs because of the COVID-19 pandemic.
Typically, employer-sponsored “leave donation” programs allow employees who have accrued sick, vacation, or personal leave that they don’t need to donate to a pool to be used by others. Under the program, other employees who need to take more time than they have accrued – perhaps because they are sick or need to stay home for their family – can “take” some leave from the bank. That sounds terrific, right?
For tax purposes, employees are typically taxed on leave when the leave can be used (you already knew that part, right?). Employees can also be taxed on leave when they have the opportunity to dispose of the leave (for example, some companies allow employees to cash out leave). So that means that employees could be taxed when they qualify for the leave – even if they toss it into the pool for other employees to use.
Fortunately, there are exceptions to this rule, and they’ve been around for a while. Notice 2006-59 (downloads as a PDF) describes how leave-sharing plans which are used during a major disaster will not result in adverse tax consequences.
With its latest guidance, the IRS has now made clear that under leave donation programs, employees who elect to forgo vacation, sick, or personal leave for other employees to use during the COVID-19 pandemic will not be treated as having received the leave as income (and it will not be reported on a Form W-2).
Here’s why. On March 13, 2020, the President, acting under the Stafford Act, (42 USC 5121 et seq.), issued major disaster declarations for each of the 50 states, the District of Columbia, and five US territories. In other words, everywhere in the United States currently qualifies as a disaster, and that means that the disaster relief exception can apply to all leave donation programs so long as they meet the rules. The rules include, among other things, that the details of the program must be in writing and must not allow employees to opt for cash instead of leave.
So why might employees want to donate their leave? For one, there’s the whole warm-fuzzies bit: it’s a nice thing to do. Additionally, under the plan, employees agree to give up their leave in exchange for the employer making an equivalent cash donation to a charitable organization – that means that you’re helping your fellow employees and a charity to boot. Finally, there may be one more bonus: employees in states with “use-it-or-lose-it” leave policies can donate leave that they would have otherwise be taxed on and lost, and not be subject to tax consequences for “earning” the leave in the first place.
Keep in mind that the employee isn’t actually making the charitable contribution – the employer is – so there’s no charitable deduction allowable for the employee. That’s okay, though, since there’s no corresponding income. From a tax perspective, it’s no harm/no foul.
So what do the employers get out of this? Hopefully, happier and (eventually) healthier employees. Also, unlike the employees, the employers can deduct those cash payments to charitable organizations either as a business expense or as a charitable contribution deduction so long as they otherwise qualify.
It feels like a win all of the way around. However, this specific relief does have an expiration date at the end of the year. You can find the details at Notice 2020-46 (downloads as a PDF).
