Making PTO payouts in uncertain times

The COVID-19 pandemic has created much uncertainty in the employment sector. One issue employers are facing is how to handle paid time off (PTO) payouts.

Avoiding constructive receipt

Many PTO plans allow employees to make an election in 2019 to cash out a certain amount of PTO during 2020. The payouts often take place once or twice a year on a set date.

The election is made in the prior year to avoid a tax rule known as "constructive receipt." If employees were given the option to either cash out or roll over unused PTO, the constructive receipt rule would say they have constructively received all of the unused PTO during that year. The result is that the employees are taxed on the full amount of the PTO—including the portion they chose to roll over to the next year, even though they didn’t actually receive the money.

By having your employees make the election in the prior year before the current year PTO has accrued, the tax issue is avoided, and they are taxed only on the PTO actually taken and the PTO payouts actually received. The PTO an employee elects to roll over to the next year isn't taxed until it is eventually paid some time down the road.

PTO FAQs

Facing a modified set of paid leave rules along with general financial uncertainty, many employers are wondering how to handle PTO payouts. Below are a few common questions we have seen pop up, along with our recommended course of action.