A number of our clients have historically maintained employee assistance and leave-sharing programs to assist co-workers and others in times of crisis. However, there are significant tax restrictions associated with such employer-sponsored programs. In the aftermath of the devastation wreaked by Hurricane Katrina, there has been a groundswell of support for the hurricane victims. As the full scope of the hurricane’s destruction has become clear, a number of employers have adopted or are considering adopting leave-based donation programs, under which employees forgo vacation, sick, or personal leave in exchange for employer contributions to charitable organizations and hurricane relief funds. Many otherwise willing employees don’t have readily expendable resources to donate to this relief effort or would like to donate more. These leave programs allow such donations by converting earned leave into charitable donations.
In a sweeping, but temporary relief program, the Internal Revenue Service (IRS) issued Notice 2005-68 announcing important exceptions to the tax limitations on such leave programs. The Notice substantially increases the favorable tax effect of making charitable contributions to recognized charities. More specifically, Notice 2005-68 provides interim guidance on the application of income and employment taxes to, and the proper reporting of, payments by employers under these programs. The Secretary of Treasury stated that these programs "give workers and businesses an easy and effective way to contribute to the charities that are doing so much to rescue, comfort and care for the victims of this terrible tragedy."
Under the Notice’s provisions, the IRS will not challenge the favorable tax treatment of any charitable contributions for Hurricane Katrina relief made by an employer prior to January 1, 2007, in exchange for vacation, sick, or personal leave that the employee elects to forgo. Participating employees do not directly claim a charitable contribution deduction regarding the value of forgone leave. Instead, the amounts assigned by the employee to the charitable organization will be excluded from the employee’s gross income and wages altogether. Accordingly, such amounts would not be included on the employee’s Form W-2 for purposes of federal income taxes, Social Security taxes, and Medicare taxes. (Boxes 1, 3 and 5 on the Form W-2.)
As indicated, these leave donation programs offer significantly greater tax advantages than if an employee were to donate the same amount directly to a recognized charity. The employees avoid federal income taxes and employment taxes on the contributions resulting in tax savings or the ability to increase donations often by more than 20%. In addition, employees avoid the charitable deduction limitations effectively imposed on taxpayers in both low-income and high-income tax brackets. Currently, many individuals in lower income tax brackets do not receive any tax benefits from their charitable contributions since they do not itemize their deductions. Conversely, many individuals in higher tax brackets also do not get the full tax benefits of their contributions since limitations exist on the amount of itemized charitable contributions they can effectively claim as a full deduction. For a leave contribution program established under Notice 2005-68, these limitations are completely avoided. The employer also benefits directly by saving employment taxes and also gets a full trade or business deduction rather than the more limited charitable contribution deduction.
As currently permitted by Notice 2005-68, a basic leave-based donation program can be easily adopted and administered. As with many benefits programs, other characteristics can be considered to more uniquely satisfy the specific charitable needs, desires, or goals of an employer or its workforce. We strongly urge employers to adopt such programs immediately since the generosity of the American people is extremely important to Katrina’s victims. To assist with such adoption and as a service to our clients, friends, and fellow citizens, we have created and placed on our website an easily adopted and administered program. This form document can be accessed at http://www.mwe.com/info/news/ots0905c.pdf.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
