In the wake of the fires that devastated Maui, the IRS issued Notice 2023-181 to explain the application of the tax laws to employer-sponsored programs for donations of accrued but unpaid sick or vacation time by employees.
A popular benefits trend among employers is the implementation of leave-based donation or exchange programs. In many instances these programs come about when a particular employee faces a medical emergency and needs to take more time off from their position than they have accrued or are entitled to under traditional benefits policies. Other employees with accrued leave will approach the employer offering to donate their own accrued but unpaid leave to benefit the employee in need. A charitable variation on these programs allows employees to donate their accrued time off in the form of cash (equal to the amount deemed to be the value of the time off) to a charitable cause. These programs typically are formed in the wake of a crisis, such as September 11, 2001, or a natural disaster, such as the wildfires that struck Hawaii in August.
The tax treatment of employee medical emergency leave-sharing and charitable donation programs is somewhat tricky because of the basic principle of tax law known as the “assignment of income doctrine,” which requires the person entitled to the income (or vacation/sick time) to recognize it and pay tax on it as compensation. This triggers payroll tax liability to both the employer and employee and withholding obligations as well. In the case of medical emergency leave-sharing, this characterization could result in both the employee donor and the employee recipient to recognize and pay tax on the funds. In the case of a charitable donation program, the employee donor would also be the taxpayer entitled to take a charitable deduction for their donation under the doctrine.
The IRS recognized that this is a harsh result from a tax standpoint and has issued guidance to mitigate the application of the doctrine to these benefit programs. In Revenue Ruling 90-29, the IRS recognized that in the case of medical emergency leave-sharing programs, the compensation should only be taxed once to the employee recipient of the donation and not to the donor employee, provided the employer meets certain requirements contained in a written benefit plan. The IRS also began a practice of issuing Notices to carve-out the charitable donation of accrued sick or vacation time from compensation with respect to specific crises and disasters. Thus, under Notice 2023-181, employee donations of accrued sick or vacation time to charities working to alleviate those affected by the Maui wildfires will not be taxed as compensation to the donor employee. Further, the Notice clarifies that the employer is the appropriate party to take a charitable donation deduction under Section 170 or treat the payment as an ordinary and necessary business expense under Section 162.
This tax-friendly characterization allows more funds to reach those in need, but does require an employer administering these tax-favored benefit programs to engage in more diligence and to be aware of the tax requirements involved.
To read Notice 2006-59 regarding the requirements for designing an employee leave-sharing program click here.
For a more in depth discussion of the assignment of income doctrine’s application to leave-sharing and charitable donation programs from The Tax Advisor click here.