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Potential traps for employers include the timing of, and cross-year accounting for, payroll tax liabilities from paid-time-off programs.
Many employers have paid-time-ofF (PTO) policies that allow employees to cash in some portion of their PTO when the balance reaches a certain level. Other employers offer to buy back unused PTO from their employees. (PTO refers to vacation, sick, and/or personal leave offered as an employee benefit.)
What is often overlooked in these situations is that the ability to convert unused PTO to cash constitutes constructive receipt of income and will subject the employees to taxes even if they do not receive any cash. It can also cause payroll complexities for the employer.
THE DOCTRINE OF CONSTRUCTIVE RECEIPT
Under Regs. Sec. 1.451-2(a), income not received in cash is constructively received by a cash-basis taxpayer in the tax year during which the income is credited to the taxpayers account, set apart for the taxpayer, or otherwise made available so that the taxpayer may draw upon the income at any time, or could have drawn upon it during the tax year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of the income's receipt is subject to substantial limitations or restrictions.
In the case of a plan that allows employees to convert unused PTO into cash, the 1RS consistently has held that an employee is constructively in receipt of...