IRS Notice 98-4: Rules for SIMPLE IRA Plans
Understand the tax and administrative framework of IRS Notice 98-4 for companies offering a medical emergency leave-sharing program for employees.
IRS guidance, such as Revenue Ruling 90-29, provides rules for the tax treatment of employer-sponsored leave-sharing plans for medical emergencies. This guidance establishes a “safe harbor,” a set of standards that, if met, ensure predictable tax consequences for both employees who donate leave and those who receive it.
Establishing a Compliant Leave-Sharing Plan
An employer’s program for sharing leave must be formalized through a written plan document to be recognized by the IRS, as informal arrangements do not qualify. This document must outline the specific rules that govern the donation and receipt of leave.
A feature of these plans is that employees must donate leave to a general leave pool managed by the employer. Donors cannot designate their leave for a specific colleague. The employer is then responsible for allocating leave from this pool to employees who meet the plan’s eligibility criteria.
The plan must contain a precise definition of what constitutes a “medical emergency.” This refers to a medical condition of an employee or a family member that necessitates a prolonged absence from work. The situation must also be one where the employee’s absence would result in a substantial loss of income because they have no available paid time off.
A potential recipient must have fully exhausted all of their own paid leave before they can draw from the leave bank, including any accrued vacation, sick, or personal time. The plan must require employees to submit a written application to the employer detailing the need for the additional leave.
The plan must set specific limitations on both the donation and the use of the shared leave. It must specify a limit on how much leave an employee can donate and restrict a recipient’s use of the time to the specific medical emergency. The recipient cannot receive a cash payment in place of taking the time off.
Tax Implications for Employees
For an employee who donates leave under a compliant plan, the tax consequences are straightforward and favorable. The value of the paid time off they contribute is not included in their gross income or wages for tax purposes. This means the donor does not pay any federal income tax, Social Security tax (FICA), or federal unemployment tax (FUTA) on the hours they give away.
The employee who receives the donated leave, however, faces different tax implications. The value of the leave payments they receive is considered taxable income. The tax liability is triggered only when the employee takes the leave and the employer makes a payment to them for that time off. These payments are treated identically to regular wages for the recipient.
Employer Payroll and Reporting Responsibilities
When an employee receives payments from a qualified leave-sharing plan, the employer must handle these funds as regular wages. The employer is obligated to perform all standard tax withholdings on these wage payments. This includes calculating and remitting the correct amount of federal income tax and the employee’s share of FICA taxes. These payments are also included in the wage base for calculating the employer’s FUTA tax liability.
At the end of the year, the employer must accurately report these payments on the recipient employee’s Form W-2, Wage and Tax Statement. The total amount paid to the employee through the leave-sharing plan must be included in Box 1, Box 3, and Box 5. All federal income tax, Social Security tax, and Medicare tax withheld from these payments must also be reported in the corresponding boxes on the Form W-2.