Paid time off (PTO) can be a huge perk for employees. Whether they use the PTO for extra vacations after years of pandemic restricted travel, for mental health days, or anything in between, PTO benefits can be a big factor for potential employees and in keeping current employees happy.
One option, if you have a business sponsored cafeteria plan (sometimes called a Section 125 plan), could be to let your employees purchase extra PTO.
Compliance requirements
A “PTO buying” feature under a cafeteria plan allows employees to prospectively elect, during the annual open enrollment period before the beginning of each plan year, to buy additional PTO beyond that which they’d otherwise receive from their employer. These purchases typically occur via salary reductions or flex credits.
The rules for PTO buying under a cafeteria plan are complex, but let’s review a couple of the most critical compliance requirements. First, the PTO buying feature must not defer compensation from one plan year to the next. This means that PTO bought under the cafeteria plan generally must be used, cashed out or forfeited by the end of the plan year. Employees can’t carry over the PTO for use in a later plan year.
If you opt to permit employees to cash out unused PTO at the end of the plan year, you’ll need to clearly inform them that these dollars will be included in their taxable income. Employers can also choose to set up the plan feature so that employees simply forfeit unused PTO when the plan year ends. However, before going this route, you should check into whether your state’s laws restrict such forfeitures.
Second, something called the “ordering rule” applies. The IRS refers to additional PTO bought through a cafeteria plan as “elective” PTO. The ordering rule requires employees to use nonelective PTO before elective PTO. Thus, they can use their purchased PTO only after exhausting all PTO earned under normal compensation.
The practical consequence of the ordering rule is that employees must expend all their PTO — whether elective or nonelective — to prevent a cash-out or forfeiture of any elective PTO at the end of the plan year. Thus, a PTO buying feature under a cafeteria plan may not be a good fit for businesses with PTO policies that allow employees to carry over unused nonelective PTO to future years. And, again, a buying feature might conflict with state laws that prohibit forfeiture of unused PTO.
An appealing benefit
Adding an option to purchase additional PTO to your cafeteria plan may be a great fit for your business. However, it can also be a complex option to keep up with the rules involved. The system would need to be carefully designed and managed properly. For any questions or advice on this contact your Rudler, PSC advisor at 859-331-1717.
RUDLER, PSC CPAs and Business Advisors
This week's Rudler Review is presented by Becca Thorman, CPA, CVA and Evan Kandra, CPA.
If you would like to discuss your particular situation, contact Becca or Evan at 859-331-1717.
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