Payroll Brass Tax: Understanding PTO Donation Programs—A Guide for Employers

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Mike Mahoney: The first session of Ogletree’s monthly Payroll Brass Tax podcast, where we talk about employment and payroll tax questions and issues that are frequently asked by our clients. Our goal here is to provide information for business leaders to identify issues and highlight practical considerations in addressing employment and payroll tax challenges.
I’m Mike Mahoney, a shareholder in Ogletree’s Morristown, New Jersey and New York City offices. Joining me is Stephen Kenney, an associate in Ogletree’s Dallas, Texas office. Our topic for today is paid time off or PTO donations. I know we’re frequently asked how employees can support other employees during challenging times, whether it’s due to an employee losing their home because of a fire, or being out of office due to a prolonged illness, or perhaps being displaced due to a natural disaster. There are three types of PTO donation programs that we will talk about today: general PTO donation programs, qualifying medical emergencies, PTO donation programs, and qualifying natural disaster PTO donation programs. So, with that, I’m going to start asking you some questions, Stephen. Why do employers need to be cautious in how they structure PTO donation programs?

Stephen Kenney: Thanks, Mike. Yeah, as you mentioned, the general leave sharing programs is really the one that they have to be cautious about because if you don’t hit one of the qualifying plans, then you’re in the general category, and general leave sharing programs result in taxation to the donor under the assignment of income doctrine. So, essentially, it’s considered a gift to the other employee. There’s no charitable deduction for the donor. The recipient is not even taxed. So, this is often perceived as a peculiar result because you don’t really anticipate when you’re giving PTO to somebody else that you’re going to get taxed as the donor, and it may impact an employee’s willingness to donate time.

Mike Mahoney: Can you elaborate on what the assignment of income doctrine is? That sounds complicated.

Stephen Kenney: Yeah, it can be. The assignment of income doctrine provides that income is taxed to the individual who earns it, even if the right to that income is assigned to someone else. Supreme Court Justice Oliver Wendell Holmes is credited with developing the reasoning behind the doctrine. In his 1930 tax case, Lucas v. Earle, Justice Holmes wrote that the fruits cannot be attributed to a different tree from which they grew. So, this poetic metaphor expresses the core of the assignment of income doctrine. That income is taxed to the person who earns it, even if they try to assign it to someone else. If we apply that here in the general PTO donation context, that means that if an employee has accrued paid time off, fruit in the Justice Holmes metaphor, then they can’t send it to somebody else without paying taxes on it.

Mike Mahoney: So, are there any benefits to a general paid time off donation program?

Stephen Kenney: Yes, there can be. One of the benefits is a general PTO donation program provides administrative flexibility. For example, eligibility to receive PTO may be very broad, including coverage for employees who would be ineligible under one of the qualified plans. For example, it could cover situations like when a person’s home burns down in a fire. Another benefit is that, rather than donated hours, a gift under a general program is based on the dollar value at the rate of pay of the donor. So, typically, under these programs, this is a bit of a generalization, though a higher-paid individual gifts their time. So, in return, the recipient could be getting a little extra value for their PTO since it’s donated at the rate of the higher-paid individual

Mike Mahoney: That covers PTO donation programs. And you referenced qualifying PTO donation programs. What are they, and what benefits does a qualification have?

Stephen Kenney: What makes them qualifying is that the IRS has qualified them for preferential tax treatment. The IRS has provided guidance in which two types of plans qualify for this preferential tax treatment. One is an emergency, medical emergency PTO donation program, and the other is a major disaster PTO donation program. The preferential tax treatment is that the donor of the leave is not taxed on the amount of PTO they relinquish, but instead, the recipient of the PTO is taxed when they use it. The donor of the time is still not eligible for a charitable donation on their tax return. In effect, it says, though, the time accrued to the recipient. So, the person who receives the PTO, it’s essentially going into their individual PTO bank.

Mike Mahoney: Thanks for that insight. I think we should just take them in order. So, maybe you can spend a little bit of time talking to us about the requirements for a medical emergency PTO donation program.

Stephen Kenney: First, there needs to be a written plan. The employer must establish a plan where its employees who suffer “medical emergencies” may qualify as recipients of leave surrendered to the employer by other employees or leave deposited by its employees in an employer-sponsored leave bank. There also needs to be eligible leave recipients, so that eligible recipient needs to be an employee with a medical condition or have a family member that has a medical condition that requires a prolonged absence of the employee from work for their own condition or to take care of a family member who has a condition. And that prolonged absence results in a substantial loss of income. There also needs to be an application process, and this needs to be a written application that describes the medical emergency, and it’s submitted to the employer. And the employer then uses that information to make a determination as to whether the employee is eligible for the additional leave under the leave sharing plan.

Mike Mahoney: Are there any administrative limitations that an employer needs to be mindful of in operating a medical emergency PTO donation program?

Stephen Kenney: Yes, there are. There needs to be certain restrictions. For instance, the plan must contain restrictions on the amount of leave that may be surrendered to the employer or deposited in the leave bank. And the plan must also contain rules as to the manner in which surrendered or deposited leave will be granted to eligible leave recipients. Additionally, the recipient employee must also exhaust other paid leave. The recipient employee is required to exhaust all other forms of paid leave, so their PTO, their sick leave, their vacation pay, however it is defined in the benefits plan, before they can have access to the leave bank and use that leave that’s set aside for this particular purpose.

Mike Mahoney: Thanks, Stephen. So, based on what you’re saying, this sounds like it isn’t intended for your typical cold or flu. Do you have some examples of the type of medical emergency where this PTO program would apply?

Stephen Kenney: Yes, that’s correct, Mike. Medical emergency PTO donation programs are really intended to be used when there’s a prolonged medical absence for a serious condition. Some examples of medical issues that could lead to prolonged absences could be cancer treatment, non-electives, major surgeries that lead to prolonged absences due to lengthened recovery time, heart attacks, or strokes. In sum, we’re really talking about very serious medical conditions, not the flu or common cold.

Mike Mahoney: Thanks for that, Stephen. I think that with that, let’s shift gears a bit. Can you talk about a major disaster PTO donation program and what may be required under it?

Stephen Kenney: I sure can. First, I like to think about who is the eligible leave recipient for a major disaster PTO donation program. An eligible leave recipient is any employee or when the employee’s family is affected by a major disaster, such as a presidentially declared disaster that requires the employee to be absent from work. There are also limitations placed on this type of donated leave, as well. So, donated leave for this type of program is generally limited to the donor’s normal annual leave accrual in any particular year and may not be directed to a particular recipient by the donor either. And lastly, there’s guidance that’s been issued. There’s guidance on the issuance of the leave. Under the plan, an employer is required to make a reasonable determination; that reasonable determination should be based on need as to the amount of leave a recipient may utilize from the PTO donation leave bank.

Mike Mahoney: We mentioned, or you mentioned, the administrative challenges that an employer may face under a medical emergency PTO program. What, if any, are the administrative considerations employers should be aware of in operating a major disaster PTO donation program?

Stephen Kenney: The first consideration is really timing, and here we’re talking about how the plan must include a reasonable limit on the timing of the donations and the use of the leave by the recipients. For example, during the COVID-19 pandemic, you had to consider when did it start? When did it end? When are we going to limit the donations, and when are we going to limit the amount of within that disaster period? Another consideration is the return of unused donated leave. So, after the leave period expires, except in the case of certain de minimis amounts, any leave that’s remaining in the bank after the end of the major disaster and the termination of the program, it must be returned to the donors, and it’s returned to the donors on a proportional basis. So, those who donated more should receive more back in return as a leftover leave. And lastly, employers have to consider restrictions on the use of the donated leave. Donated leave must be used for purposes related to the major disaster, and it may not be converted into cash if the recipient does not use the leave that was donated.

Mike Mahoney: Thanks for that, Stephen. Any final thoughts for businesses out there on PTO donation programs?

Stephen Kenney: Yeah, just a few. Thanks for asking. The PTO donations may be tailored by the business. So, the type of PTO donation program that best fits a business need can be driven by the issue or issues that the business is trying to solve for. For example, if you want maximum flexibility to meet individual needs of employees, a general program provides significant flexibility to administer as you see fit. If you’re trying to help an employee who’s facing a serious medical diagnosis, a medical emergency PTO policy may be best for you. If your business is trying to solve issues that arise following natural disasters, such as floods, hurricanes, or wildfires, then a major disaster policy will be ideal. Finally, a business may offer two or more of these plans. It does not need to choose if it is trying to solve for a number of different issues.
With that, I’ll send it back over to you, Mike, so you can say our goodbyes.

Mike Mahoney: Thanks, Stephen. Really informative. And everyone listening, we hope you found this episode of Payroll Brass Tax informative. We hope you’ll join us next month for another session. Thank you.

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