Federal Income Tax

Taxation of Employee Donated Sick Leave

Employees often want to donate paid sick-leave time to deserving co-workers who find themselves in a pinch. The IRS recently released another ruling, PLR 200720017, that identifies a few of the planning considerations in donating sick-leave to co-workers.

The federal tax consequences of donating paid sick-leave depends on whether the donation is made through the employer or directly from the employee and whether the recipient employee or a third party actually receive the payment.

As the recent IRS ruling sets out, where employees forfeit paid sick-leave to the employer and the employer credits the recipient employee with the donated sick-leave, the payments will only be considered taxable income to the recipient employee (for both federal income and employment taxes). This tax treatment only applies where the transfer is made pursuant to an “employer-sponsored medical leave sharing arrangement” or a “qualified employer-sponsored major disaster leave-sharing plan.”

These plans have a few specific requirements. For example, as the recent IRS ruling notes, the later type of plan only covers transfers of paid sick leave that are made pursuant to a Presidential-declared disaster. Payments associated with a major disaster that is not made pursuant to a Presidential-declared disaster do not qualify.

While not addressed in the IRS rulings, presumably donations made pursuant to these plans will not trigger a gift tax liability for the donating employee.

Absent one of these arrangements or plans, the “assignment of income” doctrine specifies that the donating taxpayer is subject to both federal income and employment taxes on sick-leave that is donated to recipient employees. The donating employee could also incur a gift tax liability for the transfer.

This would be similar to the scenario where the donating employee simply wrote a check to the recipient employee; however, the donating employee may be able to avoid a gift tax on a direct transfer if they make the payment directly to a hospital or medical provider (and the payment is applied to qualified medical expenses).

A better option might be to create a separate non-profit entity to handle these types of donations. With the non-profit, employees might be able to offset their income tax obligation with a charitable deduction (assuming that they do not run into an alternative minimum tax situation and/or their itemized deductions are not phased out due to the amount of their adjusted gross income) and there would probably be no gift tax consequences.

This option could have the added benefit of avoiding the restrictions imposed by the “medical leave sharing arrangement” and “major disaster leave-sharing plan” and the qualified medical expense limitation for the gift tax exclusion.