QUESTION: Some of our company’s employees have suffered significant financial hardships due to the COVID-19 pandemic. Our company would like to offer those employees financial assistance, but we want to do it in the most tax-effective way. Does the Code allow us to provide disaster relief on a tax-advantaged basis to employees who are suffering COVID-19-related financial hardships?
ANSWER: Code § 139 allows individuals to exclude from their federal gross income any amount they receive as a “qualified disaster relief payment.” Excludable payments include reimbursements or direct payments for reasonable and necessary personal, family, living, or funeral expenses or repair, rehabilitation, or replacement of an individual’s personal residence or its contents on account of a qualified disaster. Payments are not excludable to the extent other compensation (e.g., insurance) covered the expenses.
Typically, qualified disaster relief payments are offered in response to local or regional disasters like hurricanes or floods. But the term “qualified disaster” includes any disaster determined by the President to warrant assistance under the Robert T. Stafford Disaster Relief and Emergency Act, and such a disaster was declared nationwide in connection with the COVID-19 pandemic. As a result, if your company makes qualified payments to employees in the U.S. who have incurred qualifying expenses due to the COVID-19 pandemic, those payments should not be subject to income tax withholding, FICA, or FUTA, and should not have to be reported on employees’ W-2 forms.
There are no regulations and only one IRS ruling under Code § 139, so there is little formal guidance for employers wanting to make qualified disaster relief payments. In its ruling, the IRS cites the legislative history of Code § 139, which indicates that individuals will not be required to account for actual expenses to qualify for the exclusion, provided the amount of the payments can be reasonably expected to be commensurate with the expenses incurred. This suggests that qualified disaster relief payments can be implemented with minimal formal administration. Nevertheless, employers should consider who will be eligible for payments, what evidence of need will be required, what amounts will be provided, how the program will be communicated, how payments will be made, and how the employer will document its payments to support its federal tax deduction.
There may also be other legal considerations. For example, while Code § 139 has no nondiscrimination rules, your company’s qualified disaster relief payments may be subject to other nondiscrimination provisions under state and federal law (e.g., ADA, ADEA, Title VII). And while Code § 139 will exclude qualifying payments from federal tax, they may be taxable under state law.
Rather than go it alone, some employers may choose to work with a vendor that administers one of the employer’s other benefits, such as flexible spending accounts. One of your current service providers may already have systems in place that can facilitate your qualified disaster relief. Some electronic payment card vendors are reportedly also offering or preparing products to facilitate qualified disaster relief in response to the COVID-19 pandemic.
For more information, see EBIA’s Fringe Benefits manual at Section XXIV.F (“Disaster Relief Payments”).
Contributing Editors: EBIA Staff.