IRS Issues New Guidance on Contributing Unused Leave to Profit-Sharing Plans

This Labor Day holiday, the IRS was busy issuing new guidance for retirement plans. Of particular interest are the new rules allowing contributions of unused "paid time off" to profit-sharing plans, including 401(k) plans. According to the IRS guidance, unused paid leave may be contributed to a profit-sharing plan either as an employer nonelective contribution or as an elective deferral by the employee, depending on how the leave policy and profit-sharing plan are structured.

The basic idea is that the dollar equivalent of the unused paid leave is deposited into the profit-sharing plan, allowing the employee to avoid current taxation of these amounts. Generally speaking, the dollar equivalent of the paid leave is determined by taking the employee's hourly rate of compensation (determined using an eight-hour day for salaried employees) and multiplying it by the number of forfeited hours of leave.

Contributions of paid leave to profit-sharing plans must satisfy nondiscrimination rules and dollar limits on elective contributions, as well as applicable limits on annual additions. (For plans that use a design-based safe harbor to satisfy the nondiscrimination rules, requiring unused paid leave to be contributed as a nonelective contribution may be undesirable, since it means the plan will have to perform nondiscrimination testing that it was not previously performing.)