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Vacation Purchase Program


Chaz
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Employer wants to set up a program under which employees can purchase up to one extra week of vacation to be paid through salary deduction. Employer does not wish to offer the option for employees to "cash out" unused purchased days.

Are there any reasons why (or why not) this program should be run through the employer's cafeteria plan?

Thanks.

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Are there any reasons why (or why not) this program should be run through the employer's cafeteria plan?

Pre-tax versus after-tax? But then the new proposed regs say "In addition, a plan that only offers the choice of cash or paid time off is not a cafeteria plan and is not subject to the rules of section 125."

Unused vacation days can be forfeited (versus being cashed out) in a cafeteria plan.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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What do you mean by "pre-tax versus after-tax"? It would seem that whenever an employee "buys" vacation, the employee is merely decreasing his or her rate of compensation for the right to have a week of paid time off. This is no different than an employee taking a week of unpaid vacation. Even outside a cafeteria plan, therefore, the "purchase" of vacation is on a pre-tax basis.

What do you mean by vacation days being forfeitable (versus being cashed out) in a cafeteria plan? Under both the current proposed cafeteria regs and the previous proposed cafeteria regs, unused "purchased" vacation, while it could not be carried over, could be cashed-out or forfeited pursuant to plan design.

This raises a follow-up question: can vacation "purchased" outside of a cafeteria plan be rolled over to the next year without triggering a deferred compensation problem? The final 409A regulations indicate that a bona fide vacation program does not fit within the definition of deferred compensation.

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What do you mean by vacation days being forfeitable (versus being cashed out) in a cafeteria plan? Under both the current proposed cafeteria regs and the previous proposed cafeteria regs, unused "purchased" vacation, while it could not be carried over, could be cashed-out or forfeited pursuant to plan design.

In the original post, the employer in question doesn't want to cashout the unused days. I used the word "can" not "must".

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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masteff, I think edman was thinking (I know I was) that your original post suggested that only under a cafeteria plan can unused purchased vacation be forfeited. Did you mean that only under a cafeteria plan can an employer have a CASHOUT option? If so, I definitely agree.

Do you (or anyone else) have any thoughts about edman's deferred compensation issues? He (or she) raises some interesting questions.

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masteff, I think edman was thinking (I know I was) that your original post suggested that only under a cafeteria plan can unused purchased vacation be forfeited. Did you mean that only under a cafeteria plan can an employer have a CASHOUT option? If so, I definitely agree.

Actually I wasn't clear from your original post if you were looking at a non-cafeteria option due to the cashout issue (seemed implied by the way it was phrased), therefore I was just stating a cafeteria could have forfeiture of unused vacation.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Guest taxesquire

I tried to carefully read all the posts here - sorry if I missed something.

If you're going to have employees purchase extra vacation with pretax dollars, then you need a cafeteria plan; however, the cafeteria plan must offer at least 1 other benefit, too, like medical insurance for it to qualify. No problem with not allowing a refund for unused, purchased leave.

If the e/r did not have a caf plan set up and wouldn't be offering any other e/e-funded benefits, I would suggest the e/r simply reduce the cost of the purchased leave (something like charging the e/e 70% times leave purchased times hourly salary) to sort of account for the taxes.

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What would be the difference in the taxation "pre-tax" and "post-tax" with respect to a purchased week of vacation?

Here's the scenario I am struggling with:

Employee 1 earns $52K per year and properly elects to purchase 1 week of vacation through a cafeteria plan (which is a qualified 125 plan because it offers nontaxable benefits in addition to the vacation purchase program). As such, each paycheck is reduced by the pro-rated amount totaling $1K per year. Therefore at the end of the year, all other things being equal, Employee 1 has W-2 compensation of $51K for the year.

Employee 2 also earns $52K per year but does not elect to purchase any extra vacation time but in November goes to his employer and says "I've used all my vacation this year but I want to take a week off without pay." The employer agrees. At the end of the year, all other things being equal, Employee 2 also has W-2 compensation of $51K.

I can't see the difference between the two scenarios. By Employee 2 taking the week off without pay, he effectively "purchased" a week's vacation as did Employee 1. The only difference is that Employee 1 spread the payments out through the entire year while Employee 2 "paid" for the week all at once when he took the week off unpaid.

Unless I am missing something, the tax effect is the same even though Employee 1 purchased the week through a cafeteria plan and Employee 2 did not.

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  • 2 weeks later...
A plan offering an election between paid time off and taxable benefits (cash) is not a cafeteria plan. So you can't "buy" (salary reduce) a paid week off thru a 125 plan.

I agree, but a cafeteria plan can include elective PTO as a permitted taxable benefit through the plan and the plan otherwise complies with the requirements set forth in the proposed regs. (See 1.125-1(o)(4)).

There really isn't much guidance out there on many aspects of purchased vacation, is there?

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How can that be? As another poster to this thread stated:

"It would seem that whenever an employee "buys" vacation, the employee is merely decreasing his or her rate of compensation for the right to have a week of paid time off. This is no different than an employee taking a week of unpaid vacation."

Why wouldn't the employee's end of year W-2 comp be $51K?

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What would be the difference in the taxation "pre-tax" and "post-tax" with respect to a purchased week of vacation?

Here's the scenario I am struggling with:

Employee 1 earns $52K per year and properly elects to purchase 1 week of vacation through a cafeteria plan (which is a qualified 125 plan because it offers nontaxable benefits in addition to the vacation purchase program). As such, each paycheck is reduced by the pro-rated amount totaling $1K per year. Therefore at the end of the year, all other things being equal, Employee 1 has W-2 compensation of $51K for the year.

Employee 2 also earns $52K per year but does not elect to purchase any extra vacation time but in November goes to his employer and says "I've used all my vacation this year but I want to take a week off without pay." The employer agrees. At the end of the year, all other things being equal, Employee 2 also has W-2 compensation of $51K.

I can't see the difference between the two scenarios. By Employee 2 taking the week off without pay, he effectively "purchased" a week's vacation as did Employee 1. The only difference is that Employee 1 spread the payments out through the entire year while Employee 2 "paid" for the week all at once when he took the week off unpaid.

Unless I am missing something, the tax effect is the same even though Employee 1 purchased the week through a cafeteria plan and Employee 2 did not.

This is where you and I are misconnecting. Scenario 2 isn't a vacation purchase plan. It's an unpaid time off plan which is entirely different. Instead of looking at benefits regulations, IMO you should be looking at wage and hour laws. The DOL website page on Salary Basis employees says: "Deductions from pay are permissible when an exempt employee: is absent from work for one or more full days for personal reasons other than sickness or disability..." Note the words "full days". I suggest having a written guideline in place so it's clear how many days per year can be taken and that those must be full days. Also, you can't deduct for more days than the employee actually takes off (ie can't let an employee buy a week and they then only use 3 days).

Sorry for the earlier confusion, hope this helps.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Thanks for the clarification.

Let's put aside your exempt employee wage payment law issues, which are definitely well taken. Assume that the employees are non-exempt. And assume that the employee is absent for work for a full week other than for disability or sickness (and the absence was approved by the employer). What is your analysis of the W-2 tax consequences of my two scenarios?

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Thanks for the clarification.

Let's put aside your exempt employee wage payment law issues, which are definitely well taken. Assume that the employees are non-exempt. And assume that the employee is absent for work for a full week other than for disability or sickness (and the absence was approved by the employer). What is your analysis of the W-2 tax consequences of my two scenarios?

As long as we recognize that in scenario 2 "vacation purchase" is merely a semantic for what's really unpaid time off, then I agree. In both cases, hourly wage is $25 ($52K / 2080 hours). So...

Scenario 1: 52 weeks * 40 hours * $25 = $52K - $1000 vacation purchase = $51K

Scenario 2: 51 weeks * 40 hours * $25 = $51K

The advantage to the employee of Scenario 1 is that he/she gets a paycheck during that week (leveling of income).

The advantage to the employee of Scenario 2 is no risk of forfeiture.

The term "excused absence" comes to mind when discussing a non-exempt employee and an unpaid time off plan. Like in our factory, you get paid for a holiday only if you work the days before and after or you have an excused absence. But that's more just a thought out loud, as that seems be more what you're talking about here.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Masteff - your analysis regarding the "purchase" of vacation outside of a cafeteria plan as being a semantic for unpaid time off makes sense (i.e., it is really a leveling of income). Setting aside the wage payment law issues as requested by Chaz, the advantage you note in Scenario 2 is that there is no risk of forfeiture, which implies that there is a risk of forfeiture in Scenario 1.

Is the risk of forfeiture due to employer discretion (i.e., the employer specifies that unused "purchased" vacation cannot be carried over) or do you think that the deferred compensation rules requires that unused "purchased" vacation cannot be carried over inside or outside of a cafeteria plan? In either event, it would seem that unused "purchased" vacation cannot be sold back outside of a cafeteria plan at the end of the year without violating constructive receipt rules.

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Is the risk of forfeiture due to employer discretion (i.e., the employer specifies that unused "purchased" vacation cannot be carried over) or do you think that the deferred compensation rules requires that unused "purchased" vacation cannot be carried over inside or outside of a cafeteria plan? In either event, it would seem that unused "purchased" vacation cannot be sold back outside of a cafeteria plan at the end of the year without violating constructive receipt rules.

Based on the original post, the employer doesn't want to allow cash out, so by purchasing vacation as a block of days, this creates the risk of forfeiture.

Also IMO Scenario 1 only works under a cafeteria plan because, outside of such, you can't get around the wage and hour laws. So then a quick review of what's allowed under a caf plan might be useful... Generally speaking, in a cafeteria plan, for unused vacation days, the employer either can cashout (or apply to another benefit allowed under the caf plan) or can forfeit. Carry forward can't be allowed as it creates improper deferral of income in violation of Section 125 cafeteria plan rules.

And I'd have to think over the constructive receipt rules a little further to answer your last statement. But it would only be academic as those wage and hour laws we set aside would have sufficient weight on the analysis as to impact the outcome. So I'll simply bring those rules back into play and say you weren't permitted (outside a cafeteria plan) to deduct the unused days in the first place so they have to be restored before year-end.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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