Paid Time off Program Design Trends

Monday, October 18, 2010

Depending on the organization’s PTO program design features, employees may be required to use 100% of their accrued PTO time within the current program year of forfeit any un-used balances. The goal is to manage how much time an employee accumulates to avoid extremely large balances. Unfortunately, the employee may be left with a gap of unpaid time during a period of an illness, injury or pro-longed family emergency. Clearly, the organization must balance the competitive need to have a PTO program and the costs associated with paying for pro-longed periods with accrued PTO balances. One interesting alternative is to allow the employee to rollover some or all of the employee’s expiring PTO balances into their Defined Contribution plan.

In two Revenue Rulings, 2009-31 and 2009-32, the IRS indicates that it would be acceptable to amend an organization’s 401(k) plan to allow un-used PTO time that would otherwise expire at the end of the current plan year to be rolled into the employee’s account.

“Annual paid time off contributions. This ruling provides guidance on the tax consequences of an amendment to a tax-qualified retirement plan to permit annual contributions of an employee’s unused paid time off under the employer’s paid time off plan. A paid time off plan generally refers to a sick and vacation arrangement that provides for paid leave whether the leave is due to illness or incapacity. The amendment relates to a contribution (including a section 401(k) contribution) or cash out of the unused paid time off, determined as of the end of the plan year (December 31). Rev. Rul. 2009-31 is companion guidance to Rev. Rul. 2009-32 and is part of the “Savings Initiative’ guidance issued by the Service. “

“Paid time off contributions at termination of employment. This ruling provides guidance on the tax consequences of an amendment to a tax-qualified retirement plan to permit contributions for an employee’s accumulated and unused paid time off under the employer’s paid time off plan at a participant’s termination of employment. A paid time off plan generally refers to a sick and vacation arrangement that provides for paid leave whether the leave is due to illness or incapacity. The amendment relates to a post-severance contribution (including a section 401(k) contribution) or cash out of the accumulated and unused paid time off. Rev. Rul. 2009-32 is companion guidance to Rev. Rul. 2009-31 and is part of the “Savings Initiative” guidance issued by the Service.”

While this feature may not be attractive to every organization, it does provide an alternative to simply allowing un-used PTO to expire at the end of the year or when an employee terminates from employment. As with any situation involving the deferral of income in the present time carries with it significant restrictions. All conventional 40(k) limits apply and deferral election must be made in advance of the actual deduction occurring. Both Rev. Rul. 2009-31 and 2009-32 provide several examples of situations in which all or part of the employee’s unused PTO is deferred into the organization’s 401(k). As to be expected, both the 401(k) and PTO plans must be amended prior to deferrals taking place.

As with the design, amendment, administration, and operations of tax qualified plans such as 401(k)’s, organizations should always seek professional and credentialed account, tax, and legal advice prior to implementing any changes.