Employer Approach to Unused Leave

Q: Are there instances in which a 403(b) employer may treat accumulated sick and vacation pay, going back several years, as employer contributions on behalf of employees? Is there an applicable citation or written guidance?

A: As long as past years’ unused leave pay has NOT been available as cash (I rarely see this, but the employer may have permitted employees to cash in unused leave pay during those past years), those amounts are available for employer contributions.

Internal Revenue Code Section 403(b)(3) is the appropriate citation: It defines includible compensation as the amount earned in the most recent period that adds up to one full year of service, and provides that it may be counted for up to five tax years after severance of employment. That means the employer may make employer contributions for up to five years following severance, at 100% of includible compensation capped at $53,000 (in 2016) or $54,000 (in 2017).

Hoewever, if the unused leave pay was made available during those past years for cash-in, the employer contributions could not be made using those amounts without causing them to be elective deferrals.