Question: Several exempt employees would like to donate an accrued vacation hour to a nonexempt employee to show appreciation for his military service. Is it possible to transfer this time? And, if so, how should it be taxed for the donator and/or recipient? Also, do I need a policy for this–or no, because it is a one event?
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Answer from the experts at HR.BLR.com:
Thank you for your inquiry regarding leave donation from exempt employees to a nonexempt veteran.
Leave-sharing programs can be a popular benefit to allow employees to share pooled leave with those who, for varying reasons, may be in need of additional leave beyond what they have available. However, as you are aware, employer-provided benefits often come with tax consequences, which is also the case for most leave-sharing and donation arrangements.
When paid leave is donated to an employee, then this additional leave will be paid out at the recipient’s regular compensation rate. Except in two very limited situations (medical emergencies and major disasters), this donated leave is taxable, as it is considered “wages,” and should be treated as such for tax purposes.
In your situation, because this leave is not being donated for a medical emergency or major disaster, the recipient employee should be taxed on the value of the donated leave just as though the leave were his own accrued leave or wages.
The same limited tax exceptions apply to the donor of leave—if the hours of paid leave are being donated for a medical emergency or major disaster, then these hours of leave are not included in the donor employee’s income. However, the IRS does not offer this special tax treatment in other leave-sharing circumstances. This is considered an “assignment of income” and the donor is still taxed on the income, even though he or she ultimately assigns it to someone else. Therefore, the donor employee will also still be subject to payroll taxes on the earned and donated leave just as if he or she were using the leave him or herself.
Though the proposed situation is intended to be for a one-time event, it is still advisable to have a policy—perhaps a broader, more general policy—to list and detail circumstances in which leave donation will be allowed, subject to the discretion of HR and other appropriate stakeholders.
First, as you can see, the tax treatment of the donation can be complicated depending on the leave donation circumstances, so a clear policy can help ensure compliance with these tax rules if another leave donation event is desired in the future.
Second, a policy ensures fair and consistent treatment if, for example, workers want to undertake a similar donation in the future. Otherwise, you could run into problems if, for example, workers wish to donate leave for an employee who is pregnant, but that request is denied. Without a clear policy setting forth requirements for leave donation and receipt, this practice could otherwise appear to be discriminatory.
For additional, in-depth information and guidance on setting up a leave-sharing program and elements to consider for the related policy, you may find this article incredibly helpful.