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Tax Treatment of Accrued, Unused PTO


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PLR 9009052 states that accrued paid time off is includible in an employee's income when not subject to substantial limitations or restrictions. "Limitations & restrictions" include maintaining a minimum number of accrued hours, a maximum number of accrued hours (above which hours are automatically converted to cash & distributed to employee) and the requirement that hours be cashed in in blocks of, for instance, 40 or more. What is not clear is whether a 40 hour block of time that can be cashed out, but is not cashed out, is taxed twice: once when it is "included in income" because not cashed out, and again when it is actually converted to cash and distributed to the employee. Any comments on or experience with this issue? What is the status of IRS enforcement in this area, if any?

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  • 13 years later...

I know PTO plans are not typically covered on this board but I am hoping to obtain some guidance on some PTO policy issues via resurrection of this old thread as I am striking out on other fronts and available resources.

First to try and address Christine Roberts' original question--my understanding is that the IRS only expects employees to be taxed on the additional value (if any) accrued with respect to the delayed PTO cash-out amounts at the time of actual cash out. For example, assume that an employee that is earning $10 per hour at the end of 2013 has 40 hours of PTO leave that has built up and is available for cash out at the end of 2013 but the employee elects to roll those 40 hours over to 2014 and not take the cash. Because the employee could have taken the $400 in accrued PTO in cash in 2013 but failed to do so, the IRS views the employee as being in constructive receipt of that amount in 2013 and so taxable on $400 in 2013. Now, assume the employee gets a pay raise first of 2014 and is now earning $11 per hour and then in the Spring of 2014 uses the 40 hours of rolled over leave as vacation. Because the employee has already paid taxes on $400 worth of the PTO, he or she would only be taxed on the additional $40 in value of the PTO at the time the leave is actually taken in 2014 as a result of the $1 per hour pay raise. I am not sure I can point to definitive IRS guidance on that issue but I believe that treatment is pretty well accepted. Would be glad for any additional information to the contrary.

Now, on to my new question: I am searching for a model or go-by for a PTO policy that (1) permits employees to elect to receive cash-outs of accrued PTO in the following year in accordance with general constructive receipt guidance by the IRS. In addition, they also want to permit employees to donate a certain amount of PTO to other employees with medical emergencies in accordance with applicable tax rules. My question is whether there are strict ordering rules, etc. as to how these amounts relate to one another and how best to draft. In short, I am looking for a sample policy that incorporates both of these elements in a way that complies with tax rules. For example, a particular question relates to the PTO elections for cash outs which have to be irrevocable. I believe those can generally be drafted so that they only apply if the amounts elected to be cashed out exist at the time of the distribution such that if the employee actually wants or needs to take the leave before the cash out, that is ok and the PTO cash out amount would just be reduced accordingly without violating the irrevocability requirements. Given that, I assume the employee is also free to donate PTO amounts freely, including amounts that would otherwise be cashed out per their prior election, if a situation arises before cash out where the employee wishes to donate some leave. In short, I assume that the election for a cash out doesn't really mean those hours are removed from available PTO hours for use as vacation or medical leave but I am not sure that is how the program is intended to operate.

Many thanks for any guidance and/or suggestions on resources for sample policies or plans.

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