Tax treatment when employees surrender paid time off to benefit others.

• Author: Martin, Jeffrey A.

Hurricane Sandy had a devastating effect on many employees throughout the Northeast, causing them to miss work for a prolonged period. The days needed by some of these employees to focus on their personal lives rather than work outnumbered the days they had accrued as paid time off (PTO). As a result, these employees faced going without pay while they tried to recover from the natural disaster. Recognizing the hardships that these employees were facing, some employers implemented leave-sharing programs to allow employees to help fellow employees in need. Other employers throughout the nation implemented plans to allow employees to donate the value of their accrued PTO to charitable organizations assisting in disaster relief.

There are various types of PTO donation and leave-sharing programs, not all of which are disaster-related. The tax treatment to the donating employee differs based on the type of program. This item explores the tax treatment of various programs, including special rules that apply to certain PTO charitable donation programs and leave-sharing programs that benefit employees who are affected by a disaster, such as victims of Hurricane Sandy.

Standard PTO Charitable Donation Program

Employers may establish a program that allows employees to donate the value of a certain number of hours or days of PTO to a charitable organization. The employer gives cash to the charitable organization equal to the value of the donated PTO.

As unlikely as it may sound, except in certain circumstances described below, donating PTO generally results in a taxable event for the donating employee. Under the assignment-of-income doctrine, the donating employee is generally required to recognize compensation income equal to the value of the donated PTO. Various cases have established the assignment-of-income doctrine. In Rev. Rul. 72-542, the IRS explained how the doctrine applies to payments for personal services that are directed to a charitable organization:

It is a fundamental concept in tax law that there is realization of income to the person who has the right to receive it or the power to dispose of it, and payment directly to an exempt organization, at the direction of the person whose individual personal services earned it, constitutes an assignment of income that is disregarded for Federal income tax purposes. Simply put, an individual cannot give a vested valuable right to another person without first recognizing taxable income eaual to the value of that right.

Example: F donates the value of 20 hours of PTO to a charitable organization through a PTO charitable donation program established by his employer. F earns $30 per hour, so the value of his donated PTO is $600. F will recognize $600 of compensation income when he elects to donate the PTO. The income recognized by F must be reported to him on a Form W-2, Wage and Tax Statement, and is subject to income tax withholding, as well as Federal Insurance Contributions Act (RCA) tax withholding (i.e., Social Security and Medicare taxes). This warrants special consideration, since normally, an employer withholds these taxes from cash payments made to the employee. However, F does not receive a cash payment when he donates the PTO, but his employer must still obtain the withholding taxes from F (typically by withholding from F's normal wages), resulting in less after-tax cash for F.

Consider how F's donation affects his take-home pay: F is paid weekly. He works 40 hours a week, so his gross pay for the week is $1,200 ($30 per hour x 40 hours). Assume the amount normally withheld from his pay for federal and state income taxes and FICA tax is $300, so his take-home pay is $900. In the week he donates the PTO, he recognizes an additional $600 of income, but he does not receive it as cash. Assume that as a result of this additional income that must be recognized, the amount of federal and state income taxes and FICA tax that must be...