There’s been a lot of media attention of late to paid time off. By executive order, starting in 2017, federal contractors must give their workers one hour of paid sick leave for every 30 hours worked, up to 7 days annually. The E.O. also directs that workers can use their paid sick leave to care for themselves, a family member, such as a child, parent, spouse, or domestic partner, or another loved one, as well as for absences resulting from domestic violence, sexual assault, or stalking.
This change is expected to impact about 300,000 workers. It is the first salvo on the part of the government to eventually require private sector employers to offer paid sick leave.
Of course, many small businesses already provide sick leave, vacation days, and personal time off for their workers … all with pay. Many have more generous paid time-off policies than what the Administration is mandating for federal contractors. The reality is that many workers don’t use up their time off.
What can or should you do about the unused time off?
Policy for unused leave time
Companies generally are free to devise their own policy regarding unused vacation, sick, and personal days, subject to state law requirements. Some companies have a use-it-or-lose it policy where employees must use up their days or forfeit the benefit, assuming that state law does not mandate any paid days that employees do not forfeit. Some companies permit a carryover of unused time off, up to a maximum number of days.
Companies can set up leave-sharing banks under which employees can donate their unused leave time; other workers can make withdrawals of this time as needed (e.g., for an extended illness or longer maternity leave). Typically, these leave-sharing programs are found in large companies, but there is no reason why smaller firms can’t use them (other than the administrative cost involved). The employee donating the unused leave time is taxed on it; these taxable amounts are subject to employment taxes. However, if the plan is restricted to medical emergencies and certain conditions are met, employee donations of their unused leave time are not taxed.
Leave donation programs. Instead of sharing leave time with co-workers, companies may set up programs to donate the leave time to charity. The company makes a cash donation equal to the value of the donated leave time. Again, the employees are taxed on their donations and they are subject to employment taxes. However, the employees can take a charitable deduction for the donations they make. The company is allowed a deduction when employees make their donations; the company takes a deduction for compensation.
From time to time when there are certain disasters, the IRS may give special treatment to leave donation programs. For example, in the wake of Hurricane Katrina in 2005, Hurricane Sandy in 2012 and the Ebola outbreak in 2014, the IRS said that leave donations would not be taxable to employees; employers had a set time to make donations to charity aiding these disaster victims for which they could take a charitable contribution deduction.
Some companies pay unused time off to workers when they leave the company (e.g., resign, retire); others do not (but again check state law requirements about this). A lump-sum payment for unused sick and vacation time is treated as taxable wages. In one recent case a police detective who retired on disability argued unsuccessfully that the lump sum should be treated as tax-free workers’ compensation.
As taxable wages, they are subject to employment taxes.
HRA for retirees
While a health reimbursement arrangement (HRA) generally is no longer viable in light of health coverage requirements under the Affordable Care Act (ACA) (a temporary waiver from the $100 per employee per day penalty for HRAs viewed as impermissible expired on June 30, 2015), the IRS indicated that an HRA can be treated as an exempted plan when providing reimbursements only to retirees. An IRS Letter Ruling allowed a company to fund a HRA with retirees’ unused sick leave, saying the plan qualified as an exempted benefit. What’s more, the benefits from the HRA for medical expenses were tax free; they were not taxable to the retirees nor subject to employment taxes.
As the end of the year draws near, now is a great time to review your leave program. Going forward, decide how many days to give your employees, the company’s policy on the treatment of unused days, and whether to adopt a leave-sharing or leave-donation program. Be sure to communicate to your employees any changes you make in your leave program.