What rules apply to “PTO buying” under a cafeteria plan?
The novel coronavirus (COVID-19) pandemic has forced many people to cancel or postpone vacations, as well as travel plans to visit friends and family. While staying home to stay safe — and, often, to telework — many employees may not use as much paid time off (PTO) this year as they normally would.
In a spirit of optimism, one hopes the situation next year will be much improved. Assuming that’s the case, employees may want to take longer vacations and, therefore, appreciate the opportunity to buy additional PTO under your organization’s cafeteria plan for 2021.
A “PTO buying” feature under a cafeteria plan allows employees to prospectively elect, during the annual open enrollment period before the beginning of each plan year, to buy additional PTO beyond that which they’d otherwise receive from their employer. These purchases typically occur via salary reductions or flex credits.
The rules for PTO buying under a cafeteria plan are complex. Here are just a couple of important legal points to keep in mind:
1. No deferred compensation. The PTO buying feature must not operate to defer compensation from one plan year to the next. This means that PTO bought under the cafeteria plan for use during a plan year generally must be used, cashed out or forfeited by the end of that plan year. Employees can’t carry over the PTO for use in a later plan year.
2. The ordering rule applies. The IRS refers to additional PTO bought through a cafeteria plan as “elective” PTO. A special ordering rule requires employees to use non-elective PTO before elective PTO. Thus, they can use their purchased PTO only after exhausting all PTO earned under normal compensation.
The practical consequence of the ordering rule is that employees must expend their PTO — whether elective or non-elective — to avoid a cash-out or forfeiture of any elective PTO at the end of the plan year. So, a PTO buying feature under a cafeteria plan may not fit well with a PTO arrangement plan that allows unused non-elective PTO to carry over to future years. A buying feature might also conflict with state laws that prohibit forfeiture of unused PTO.
Assess the feasibility
Adding a PTO buying feature to next year’s cafeteria plan may be a good way to boost employee morale this year. But this feature is complex, so be sure to obtain the advice of experienced benefits counsel before amending your cafeteria plan. Our DSF business consultants can help you assess the feasibility of the idea. Contact us for more information.