To enable workers to help victims of the pandemic, employers can set up vacation-based donation programs to make cash contributions to charitable organizations, as described in Section 170 (c) of the Internal Revenue Code (the Code).
Just over a year ago, the IRS issued Notice 2020-46 detailing such vacation-based donation programs and providing guidance on state income and employment tax treatment of the value of employee vacation donated. While the guidance in Notice 2020-46 expired on December 31, 2020, the IRS recently issued Notice 2021-42, which retrospectively extends the state income and payroll tax treatment described in Notice 2020-46 to qualifying contributions made prior to on January 1, 2022.
Tax treatment of vacation entitlements
Vacation donation programs allow employees to forego vacation, illness, or personal vacation if their employer pays a cash payment to a nonprofit that supports victims of COVID-19. Pursuant to Notice 2020-46 and Notice 2021-42, these cash payments will not be treated as wages or otherwise included in the gross earnings of employees if the payments:
- 1. To a charity described in Section 170 (c) of the Code that provides assistance to victims of the COVID-19 pandemic in the United States or the five US Federal Declaration of Disaster Territories, and
- 2. Paid to such a non-profit organization under Section 170 (c) prior to January 1, 2022.
Accordingly, employers should not include these payments in Field 1, 3 (if applicable), or 5 of Form W-2 for employees waiving vacation, sick leave, or personal vacation under these vacation-based donation programs.
Tax treatment of charitable donations
Employees who forego their vacation under these vacation donation programs are not entitled to a donation deduction under Section 170 of the Code for the value of vacation donated. However, employers can deduct cash payments as part of these donation programs on leave in accordance with Section 170 (as a charitable grant) or Section 162 (as business expenses) of the Code, provided that the requirements for such a deduction are otherwise met.