Question: One of our employees died. Our HR manager would like to allow employees to donate their vacation time to the family and she’s asked Payroll for some guidelines. What can we tell her?
Answer: It sounds as if HR wants to set up a leave-sharing program. The IRS allows two types of tax-favored leave-sharing programs where employees’ donations aren’t taxable to them, but are taxable to the recipients—leave for medical emergencies and leave taken in the aftermath of a presidentially declared disaster. Your leave-sharing program doesn’t seem to fit either, so donors will continue to be taxed on the value of the leave donated and, since recipients will receive the value of the leave after the employee died, the leave will be FICA taxable.
There’s another complication for you, too. The donated leave must be reported on the deceased employee’s final Form W-2 as Social Security and Medicare wages and taxes only. You must also report the payment on Form 1099-MISC, in Box 3. Use the name and Taxpayer Identification Number of the recipient (i.e., the deceased employee’s beneficiary or estate).