Paying Taxes on a Paid Time Off Cash Out

Employees look forward to their time off when they are working 8-12 hours/day in this tough economy. Paid time off (PTO) plans vary on when the time off may be paid or used. Some employers have a use-it-or-lose-it plan that let employees accumulate days, months or even years of PTO, but if they do not use the time off, they do not get paid for it.

Paid Time Off Cash Out

Some employers allow employees to sell unused PTO back to the company at the end of the year. If an employee is able to cash out the PTO or roll it over to the next year, the IRS has ruled the employee must be taxed immediately on the entire amount that could be cashed out despite the employee electing to roll over the unused PTO.

Under the federal income tax constructive receipt doctrine, amounts available for receipt by a taxpayer are treated as received, and taxable, even if the taxpayer decides to defer actual receipt of the amount. This is similar to deferred compensation.

To avoid the tax, the employer can design the PTO to not give the employee a choice. The employer can either make the cash out mandatory or not let the employee cash out the PTO.

Tax Consequences and Considerations of PTO

Companies need to take tax consequences into consideration when making business decisions and creating employee benefit plans. Individuals that have responsible positions in a company could be personally liable for the company’s unpaid taxes in certain states. This trend stems from the increase in company bankruptcies from 2007 to 2010. In these years, the number of U.S. companies filing for Chapter 7 or Chapter 11 bankruptcy almost doubled.

Responsible person liability may apply for sales and use taxes, withholding taxes, corporate income taxes, and taxes administered by a state taxing authority. Responsible person issues arise following bankruptcy, dissolutions, and liquidations. Joint and several liability may apply to multiple responsible persons within a company.

In some states, individuals may be liable for all of a company’s taxes. For instance, Virginia law states any officer or employee who willfully fails to pay “any tax administered by the Department” may be liable for the tax. The Colorado statute is similar to Virginia, and applies responsible person liability to any tax administered by Article 21.10 Under Article 21, the Colorado Department of Revenue administers 13 taxes, including corporate income tax, sales and use tax, withholding tax, cigarette tax and gasoline tax.

To avoid unintended tax consequences, contact our experienced business tax attorneys today.


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