QUESTION: Our company allows employees to carry over unused vacation pay from one year to the next, so some employees have significant unused vacation pay balances. What would the tax consequences be if we allowed those employees to donate some or all of their unused vacation pay as a charitable contribution?
ANSWER: The federal tax consequences of charitable leave donations are usually similar to what they would be if the employee had received the vacation pay and made the charitable contribution on their own. The donated leave is treated as an “assignment of income” that is taxable to the donor employee and subject to federal income tax withholding and other applicable employment taxes (e.g., FICA and FUTA).
The IRS has occasionally recognized exceptions to this rule, however, following extraordinary events such as the September 11 terrorist attacks, certain major hurricanes, and other natural disasters. While these exceptions initially were rare, they have become more frequent and their terms and conditions have become more uniform. Generally, cash payments made by employers to “qualified tax-exempt organizations” in exchange for vacation, sick, or personal leave that employees elect to forgo are not treated as income to the employees if the payments are (1) made for the relief of victims of a designated disaster; and (2) paid by the employer to the organizations before the designated deadline. (For this purpose, a qualified tax-exempt organization includes religious, charitable, and educational organizations.) Typically, the contribution periods extend for more than a year. For example, charitable contributions for Hurricane Michael (which struck in October 2018) must be paid before January 1, 2020.
In each instance, the IRS has also (1) affirmed that the mere opportunity to make a leave donation would not result in constructive receipt of income for employees who chose not to donate; (2) noted that employees who make donations cannot deduct the value of the donated leave on their income tax returns (that would be “double-dipping”); and (3) assured employers making the contributions that they would be permitted to deduct the payments as trade or business expenses without regard to the restrictions under Code § 170. (Among other things, Code § 170 generally limits a corporation’s aggregate charitable contribution deductions for any taxable year to 10% of its taxable income.)
If your company decides to implement a charitable leave donation program, it can choose to limit contributions to only a few designated charities (which might simplify administration) or allow employees to select from many organizations. In either case, consider distributing written guidelines that clarify how the program works and where employees can send their donations. Also, check state-law requirements, especially if you consider extending your program to other types of leave, such as sick days, since treating leave as sufficiently earned to include in a leave donation program might alter how that leave is treated for other purposes.
For more information, see EBIA’s Fringe Benefits manual at Section XXII.E (“Leave-Sharing and Other Donation Programs”).
Contributing Editors: EBIA Staff.