People who donate leave to needy fellow employees sometimes live the idiom that "no good deed goes unpunished," because they might end up paying taxes on that donation rather than receive a deduction. To deduct donated leave, an employer must set up a special company just to handle these transactions. Instead of this administrative burden, it usually makes more sense to shift the tax burden to the recipient.
In most situations, you cannot deduct paid time off donated to another employee, according to Barley Snyder LLC. Actually, you might pay income tax on donated leave, despite another employee receiving your pay. This happens because the Internal Revenue Service imposes tax on earned income -- whether or not you use it on yourself. The exception is when an employer sponsors a leave donation program. Then, the recipient typically incurs the income tax obligation.
One possible way for employees to deduct donated leave is for the employer to create a tax-exempt nonprofit. In this scenario, employees could claim a charitable donation deduction. However, setting up a nonprofit that qualifies as tax-exempt and that can accept a tax-deductible donation would not be simple, because the nonprofit must apply for tax-exempt status with the IRS and follow regulations for a 501(c)(3).
Tax-Beneficial Leave Donation
Some employer-sponsored leave donation programs disregard the value of paid time off for taxes, such as donations to Katrina victims or employees with medical emergencies. In other words, the IRS does not tax this as income and, thus, you do not need a tax deduction. On most returns, the taxpayer would have the same tax liability whether he took a charitable contribution, which requires itemizing, or the standard deduction, according to the IRS.
Employers should set up a plan with a tax professional so that taxable income shifts from the donor to the recipient. Any plan that has an employee donate leave directly to another employee, for instance, usually leaves the donor with taxable income. As an individual, you can possibly donate leave on your own without incurring taxable income. The IRS allows taxpayers to avoid the gift tax, for instance, by paying another person's medical expenses to a hospital or medical care provider. Again, a tax professional can give guidance on how to do this to avoid tax consequences.