Letting Employees Donate PTO to a Coworker in Crisis: How Leave-Sharing Plans Work

One of your best people has burned through every hour of paid leave sitting at a hospital bedside, and the paychecks are about to stop. Across the office, coworkers with healthy PTO balances are asking the same question: "Can I just give some of my vacation time to them?" It feels like the simplest kindness in the world — until payroll asks who owes tax on those hours, and the answer turns out to be the person who gave them away.

That surprises almost every small employer the first time it comes up. Under the default federal tax rules, donated leave is still the donor's income. The coworker who surrendered a week of vacation to help a colleague gets the tax bill for a week of pay they never received, and cannot even claim a charitable deduction for it. The IRS carved out exactly two exceptions to this rule — one for medical emergencies, one for major disasters — and each comes with a checklist of requirements. Miss one, and the tax snaps back onto the donor. Here is how to run a leave-sharing plan that actually protects the generous people in your company.

Why Donated PTO Is Taxable by Default​

The problem is a doctrine tax lawyers call constructive receipt, paired with the assignment-of-income principle: you cannot dodge tax on pay you already earned by directing it to someone else. Accrued PTO is deferred wages. When you elect to forgo it — even for the most generous reason — the IRS treats you as if you received the cash and passed it along.

In practical terms, that means three painful results for an informal, undocumented PTO gift:

• The donor recognizes ordinary wage income equal to the value of the leave surrendered, and the employer should withhold income and payroll taxes from the donor accordingly.
• The donor gets no charitable contribution deduction, because the gift went to a coworker rather than a qualified charity, and in any case you cannot deduct the value of donated services or forgone wages.
• The recipient may also face tax on the time off they take, depending on how the employer books it — which means the same hours can effectively be taxed twice.

Only about 12 percent of employers with a combined PTO plan offer a formal donation program, according to SHRM benefits survey data — yet informal coworker-to-coworker gifts happen far more often than that, usually with nobody thinking about the tax mechanics. A written, IRS-compliant leave-sharing plan is what moves the tax from the donor to the recipient. There are two approved designs, and they are not interchangeable.

Exception 1: Medical Emergency Leave-Sharing Plans​

The older and more commonly used exception comes from Revenue Ruling 90-29, issued back in 1990. It covers employees facing a medical emergency — their own or a family member's — and it shifts taxation to the recipient only if every one of the following conditions is met.

The plan must be in writing. A handshake understanding, an all-hands email saying "donate your PTO to help out," or a policy invented after the crisis started does not qualify. Write the plan before anyone needs it: who is eligible to give and receive, what counts as a qualifying emergency, how to apply, how need is determined, and what happens to unused donated leave.

Donations go into a leave bank, not to a named person. This is the requirement employers violate most often. Donors must surrender leave to an employer-sponsored pool for use by any qualifying employee. The moment a donor earmarks hours "for Maya in accounting," the arrangement stops being a qualified plan and the donor is taxed. You can absolutely tell the team that the bank exists because a colleague is in need — you just cannot let donors direct their hours to that colleague specifically.

Recipients must have a genuine medical emergency. The ruling defines this narrowly: a medical condition of the employee or a family member that will require the prolonged absence of the employee from duty and will result in a substantial loss of income because the employee will have exhausted all paid leave available apart from the plan. A rough flu season does not qualify. A surgery with an eight-week recovery, a child's cancer treatment, or a spouse's extended hospitalization does.

Recipients must exhaust all other paid leave first. Before touching the bank, the recipient has to use up their own vacation, sick days, PTO, and any other paid leave the employer offers. The bank is the payer of last resort, not a top-up that lets recipients hoard their own balances.

The employer must reasonably determine need, and payments cannot exceed it. Someone — HR, the owner, a small committee — reviews each application, verifies the medical emergency (typically with a doctor's certification, handled confidentially), and approves only enough banked hours to cover the income loss. Whatever is not needed stays in the bank or goes back to donors.

Unused donated leave is returned. If donations exceed what recipients use, the surplus goes back to the donors, generally on a pro rata basis. Donors cannot cash it out, convert it to a bonus, or redirect it to charity through this plan.

When all six conditions hold, the tax treatment flips into its sensible shape: the recipient includes the value of the banked leave in gross income as wages (with normal withholding), the donor recognizes nothing, and the donor claims no deduction. The employer takes its compensation deduction when payments are made to the recipient — not when donors surrender leave into the bank.

Exception 2: Major Disaster Leave-Sharing Plans​

The second exception, in IRS Notice 2006-59, covers a different kind of crisis: employees adversely affected by a major disaster formally declared by the President under the Stafford Act. Think hurricanes, wildfires, floods, and — as the IRS confirmed in published FAQs — the COVID-19 pandemic. A house fire that destroys one employee's home is devastating, but unless it sits inside a presidentially declared disaster area, it does not qualify for this exception.

The architecture mirrors the medical-emergency plan with a few disaster-specific twists:

• Written plan and leave bank, same as above. Donors deposit accrued leave into an employer-sponsored pool. No earmarking donations for specific coworkers.
• "Adversely affected" means severe hardship. The disaster must have caused severe hardship to the employee or a family member that requires the employee to be absent from work — a destroyed home, an uninhabitable rental, a family member injured in the event. Inconvenience alone does not qualify.
• Reasonable timing windows. The plan should set a reasonable period for donors to deposit leave after the disaster and a reasonable period for recipients to use it. Open-ended banks that linger for years invite IRS scrutiny.
• Same tax shift. Recipients are taxed on what they receive, donors are not taxed and get no deduction, and the employer deducts payments when made to recipients.

Note what this exception does not cover: it does not bless PTO donations for parental leave, bereavement, a coworker's sabbatical, or generalized financial hardship. Those are all kind impulses, and every one of them leaves the donor taxable under current guidance. If you want to help in those situations, route the generosity through a different channel — a bona fide bonus, a qualified disaster relief payment under Section 139 where one fits, or simply extra paid leave granted by the company — rather than dressing it up as a leave-sharing plan the IRS would not recognize.

The Five Mistakes That Blow Up the Tax Treatment​

Most failed plans do not fail on exotic technicalities. They fail on the basics, usually because the policy was written in a hurry during an actual emergency.

1. Letting donors name the recipient. Worth repeating because it is the single most common failure: direct coworker-to-coworker transfers are never qualified under either exception. The bank structure is mandatory, not decorative.

2. Approving non-qualifying reasons. Bonding leave for a new baby, time off after a death in the family, leave to care for an aging parent without a qualifying medical emergency — none of these fit Rev. Rul. 90-29 or Notice 2006-59. Every hour paid out for a non-qualifying reason is taxable to the donor who funded it.

3. Skipping the exhaustion requirement. For medical-emergency plans, the recipient's own paid leave balance must hit zero before bank hours flow. Approving bank leave while the recipient still holds vacation days disqualifies the payment.

4. Withholding from the wrong paycheck. Once a plan qualifies, the donated leave is the recipient's wages, taxed at the recipient's rate with federal income, Social Security, Medicare, and applicable state withholding taken from the recipient's check. Payroll systems need a distinct earnings code for banked leave so the dollars land on the right W-2. Mis-coding them onto the donor's W-2 creates a correction project nobody wants in January.

5. Confusing leave-sharing with leave-based charitable donations. A separate family of programs lets employees surrender PTO so the employer donates the cash value to charity. Under the general rule, those donors are still taxed on the surrendered leave — the IRS has only granted exceptions through narrow, disaster-specific notices (as it did after major hurricanes and the COVID-19 pandemic). Do not assume your PTO-for-charity drive gets the same treatment as a medical-emergency bank. It almost certainly does not.

State Law and HR Traps Beyond the Tax Code​

Federal tax treatment is only half the compliance picture. Several states treat accrued vacation and PTO as earned wages that vest as work is performed — California is the strictest example — which means donations must be genuinely and demonstrably voluntary. The employer carries the burden of proving nobody was pressured, so put the voluntariness in writing, never tie donations to performance reviews or team expectations, and keep a signed authorization from every donor. In these states you also cannot use the plan as a back door to confiscate leave: returned surplus must actually go back to donors' balances.

Medical privacy needs its own workflow. Applications will contain diagnoses, prognoses, and family health details, so route certifications to as few people as possible, store them separately from personnel files as the ADA requires for employee medical records, and train approvers to confirm only eligibility — never to circulate the underlying details.

A few more design choices separate durable plans from fragile ones:

• Set minimums and maximums. Many employers require donors to keep a reserve balance (for example, 40 hours) and cap individual donations per year, which keeps one generous employee from giving away leave they will need themselves.
• Coordinate with other benefits. Decide in advance how banked leave interacts with FMLA job protections, short-term disability waiting periods, workers' compensation, and any state paid family or medical leave program. Running them concurrently where the law allows usually stretches every benefit furthest.
• Apply the rules consistently. Nothing poisons a leave bank faster than approving one popular employee's borderline request after denying another's. Written criteria, a standard application form, and the same reviewers for every case keep the program — and your discrimination-risk profile — defensible.

The Bookkeeping Side: A Leave Bank Is a Moving Liability​

Every hour of accrued PTO on your balance sheet is a liability — wages you owe but have not paid yet. A leave-sharing plan moves pieces of that liability between employees and across pay periods, and sloppy tracking turns a kindness program into a reconciliation mess.

Get three postings right. First, when a donor surrenders hours, reduce that employee's accrued-leave liability without recording a pay event or wage expense — no one was paid; the hours simply moved into the bank pool. Second, when the recipient draws banked hours, record ordinary wage expense and the associated payroll tax liabilities exactly as you would for any paid leave, coded to a dedicated earnings type so donor W-2s stay clean. Third, when surplus hours return to donors, restore their accrual balances; do not let returned hours evaporate into an unreconciled plug.

Reconcile the bank the way you would a petty-cash drawer: hours in, hours out, hours returned, and the remaining pool balance should tie every pay period. Keep the approval paperwork behind each disbursement — the application, the need determination, the medical certification reference — because that file is what proves to an auditor years later that each payment met the plan's qualifying rules. If your books live in plain text, a dedicated set of accounts for the leave bank makes the whole trail reviewable in a single ledger search; the documentation walks through structuring payroll and leave accounts so each of these movements stays visible instead of dissolving into one opaque wages line.

Setting Up a Plan Before Anyone Needs It​

The worst time to write a leave-sharing policy is the week someone needs it. The best time is this quarter, when you can think clearly about design instead of improvising under emotional pressure. A solid setup checklist:

1. Adopt a written plan covering both tracks you want — medical emergency, major disaster, or both — with definitions copied closely from Rev. Rul. 90-29 and Notice 2006-59.
2. Create the bank mechanics: donation forms with voluntary-consent language, minimums and maximums, a pooled balance the payroll system tracks separately from individual accruals.
3. Build the application packet: a request form, a medical-certification or disaster-impact statement, reviewer roles, approval criteria, and a retention schedule for the records.
4. Configure payroll with a dedicated earnings code for banked leave, withholding mapped to the recipient, and W-2 reporting tested before the first real disbursement.
5. Coordinate the benefits map: how bank leave stacks with FMLA, disability, workers' comp, and state paid-leave programs.
6. Communicate once, clearly: a one-page explainer telling employees the bank exists, what qualifies, that donors cannot pick recipients, and that donations are voluntary and irrevocable once used.
7. Review annually: confirm the plan text still matches current IRS guidance, audit the bank balance, and verify unused hours were handled per the plan.

Run through that list and the next crisis becomes an administrative routine instead of a scramble: the application arrives, the reviewers verify, payroll codes it correctly, and the donor's generosity costs them exactly what they intended to give — the time off, not a surprise tax bill on top of it.

Keep Your Books Clear While Your Team Takes Care of Each Other​

A leave-sharing plan is one of those rare policies that is simultaneously a kindness and a compliance project: the compassion is in the idea, but the protection for your donors lives entirely in the paperwork, the payroll coding, and the reconciled leave balances behind it. Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data — no black boxes, no vendor lock-in. Get started for free and see why developers and finance professionals are switching to plain-text accounting.