Like many employers, you may allow employees to carry over unused vacation pay from one year to the next. With the year winding down, and gift giving on the minds of many, certain staff members might inquire about donating their unused vacation pay to charity. In turn, you may wonder: is doing so allowed under IRS rules?
‘Assignment of income’
Indeed, it is. For federal tax purposes, charitable leave donations are typically treated as if the employee had received the vacation pay and made the charitable contribution on his or her 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 (such as Federal Insurance Contributions Act and Federal Unemployment Tax Act).
The IRS has occasionally recognized exceptions to this rule following extraordinary events such as the September 11 terrorist attacks and certain natural disasters. Although these exceptions are historically rare, they have become more frequent and their terms and conditions 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:
- Made for the relief of victims of a designated disaster
- Paid by the employer to the organizations before the designated deadline
Qualified tax-exempt organizations include religious, charitable, and educational organizations. Contribution periods usually 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.
IRS affirmations
The IRS has affirmed that the mere opportunity to make a leave donation will not result in constructive receipt of income for employees who choose not to donate. The agency also has noted that employees who make donations cannot deduct the value of the donated leave on their income tax returns as a charitable contribution — that would be ‘double-dipping.’
Finally, the IRS has 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 Internal Revenue Code Section 170. Among its various stipulations, Sec. 170 generally limits a corporation’s aggregate charitable contribution deductions for any taxable year to 10 percent of its taxable income.
A formal program
If your organization decides to implement a formal charitable leave donation program, it can choose to limit contributions to only a few designated charities, which might simplify administration. Or you could 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 are considering extending your program to other types of leave, such as sick days. Treating leave as sufficiently earned to include in a leave donation program might alter how that leave is treated for other purposes. Contact us for help establishing a program or answering any questions about donating vacation pay.