When it comes to running a business, you’re constantly looking for new ways to boost employee morale and increase employee retention. One solution? Creating a leave donation program. But, what is leave donation, exactly? And, how does it work when it comes to taxes?

What is leave donation?

Leave donation, or leave sharing, is a policy that allows employees to donate accrued paid time off or vacation or sick leave to a charitable pool or bank for other employees to use. 

Employees can use the leave to take time off for unexpected events if they’re out of available paid leave. For example, an employee may dip into the leave share pool when they run out of PTO to take time off for a medical emergency.

A leave sharing program can:

• Enhance employee morale
• Increase productivity
• Reduce absenteeism
• Improve recruiting
• Retain employees

The type of leave employees can donate may vary from state to state. Each state has different rules regarding an employee’s right to certain kinds of leave and what kind of leave employees can donate to a leave donation program. Check with your state for more information on leave sharing rules. 

Leave sharing plan and taxes

When it comes to leave sharing and taxes, any leave earned by one employee and donated to another is still taxable for both employees. However, the IRS has two exceptions to this rule which allow employees to donate leave without negative tax consequences to the employee donating their time:

1. Medical emergency
2. Major disaster

Under both medical emergency and major disaster plans, donor employees cannot claim an expense, tax deduction, or charitable contribution for any of the leave donated. 

Amounts paid to recipients are considered wages and are subject to FICA tax withholding, FUTA tax, and other required tax withholdings.

Each exception has specific requirements employers and employees must follow. 

Medical emergency

An employee can donate excess paid leave to another employee in the event of a medical emergency. A medical emergency is defined as:

A medical condition of the employee or a family member that will require the prolonged absence of the employee from duty and will result in a substantial loss of income to the employee because the employee will have exhausted all paid leave available apart from the leave sharing plan.

Generally, an employee who has exhausted paid leave may draw from the leave bank if they need more time off if they:

• Experience a medical emergency
• Need to tend to a parent, spouse, or child with a medical emergency
• Need additional time off for bereavement for the death of a parent, spouse, or child

For an employer-sponsored leave sharing program for medical emergencies, the plan should:

• Be in writing and administered by the employer
• Be created as a leave bank or pool for employees to deposit donated leave, and from which, leave will be distributed to recipients who have a personal or family medical emergency
• State that employees should be eligible to receive leave only after their request has been approved and all other available paid leave has been exhausted
• Specify that leave is to be used only for qualified medical emergencies (including bereavement in some cases)
• Outline and specify limits on the amount of leave that may be donated by an individual in any given year
• Have a detailed procedure for employees to submit a written request for leave that describes the specific medical emergency or medical condition
• Have processes to confirm that all leave transferred under the plan is actually being used for medical leave by the recipient

Major disaster

A major disaster is defined as:

A major disaster as declared by the President under § 401 of the Stafford Act, 42 U.S.C., section 5170, that warrants individual assistance or individual and public assistance from the federal government under that Act or a major disaster or emergency as declared by the President pursuant to 5 U.S.C., section 6391, in the case of employees described in that statute.

Once the president declares a major disaster (e.g., COVID-19), the IRS allows leave donations to employees affected by the disaster without negative tax consequences. 

An employer-sponsored leave sharing program for major disasters must meet the following requirements:

• Plans must be in writing
• The plan must allow a leave donor to deposit unused accrued leave in an employer-sponsored leave bank for the benefit of other employees who have been adversely affected by a major disaster
• The plan does not allow a donor to specify a particular recipient of their donated leave
• The amount of leave donated in a year may not exceed the maximum amount of leave that an employee normally accrues during that year
• A leave recipient may receive paid leave from the leave bank at the recipient’s normal compensation rate
• The plan must provide a reasonable limit on the period of time after the disaster has occurred, during which leave may be donated and received from the leave bank, based on the severity of the disaster
• A recipient may not receive cash in lieu of using the paid leave received
• The employer must make a reasonable determination of the amount of leave a recipient may receive
• Leave deposited on account of a particular disaster may be used by only those employees affected by that disaster. 
  • Any donated leave that has not been used by recipients by the end of the specified time must be returned to the donor within a reasonable time so that the donor may use the leave
  • The amount of leave returned must be in the same proportion as the leave donated.

For more information, check out IRS Notice 2006-59. 

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Establishing a leave sharing plan

Before creating a leave sharing policy, weigh the pros and cons of the plan for your business. If you decide to go the leave-based donation program route, include information about:

• Employee eligibility for using donated leave
• Employees who can share leave
• Steps to donate leave to the pool/bank
• Requirements to use donated leave (e.g., medical emergency)
• Maximum amount employees can donate
• Total amount a donor employee can take from the pool
• Value of donated leave (e.g., recipient’s rate of pay)
• Time frames for use of leave
• Proof of qualified leave
• Tax rules
• Other rules and requirements

Once you establish a PTO donation plan, let employees know how they can participate if they’re eligible. And, consider having each employee sign a leave donation form to ensure they know and understand the plan’s rules. Keep the form in your employee records for safekeeping and easy access. 

This article is updated from its original publication date of June 14, 2012.

This is not intended as legal advice; for more information, please click here.