As more businesses begin to re-open their doors and consider ways to provide a safe environment for their employees in light of the COVID-19 pandemic, employers may find that many of their employees are facing or continuing to face new and unprecedented challenges. These challenges frequently come at a cost. In order to provide employees with assistance and encourage them to return to work despite these additional costs, employers may want to consider offering tax-free “qualified disaster relief payments” to employees.
Tax Benefits of Qualified Disaster Relief Payments
Section 139 of the Internal Revenue Code (the “Code”) excludes from a taxpayer’s gross income certain payments to individuals to reimburse or pay for expenses related to a “qualified disaster.” Because state laws differ, qualified disaster relief payments may or may not be excluded from state income tax. These payments are also fully deductible for the employer. The IRS does not require qualified disaster relief payments to be reported or disclosed by employers or employees, including via Form W-2 or 1099. They are also not subject to federal tax withholding obligations. Section 139(c)(2) of the Code provides that for purposes of section 139 of the Code, the term “qualified disaster” includes a federally declared disaster, as defined by 165(i)(5)(A) of the Code.
COVID-19 is a “federally declared disaster”
On March 13, 2020, President Trump issued a proclamation declaring that the ongoing Novel Coronavirus Disease (COVID-19) outbreak, warranted a nationwide emergency declaration under the Disaster Relief and Emergency Assistance Act, 42 U.S.C. §§ 5121-5204c (1988 & Supp. V 1993). The IRS has expressly stated that the COVID-19 pandemic is a “federally declared disaster,” as defined by section 165(i)(5)(A) of the Code. Based on President Trump’s declaration, COVID-19 meets the definition of a qualified disaster. This declaration permits employers to provide tax-free assistance to their employees under Section 139 of the Code.
What is a “qualified disaster relief payment?”
A “qualified disaster relief payment” is defined by section 139(b) of the Code to include any amount paid to or for the benefit of an individual to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster. It is important to note, qualified disaster relief payments do not include income replacements such as sick leave or other paid time off paid by an employer. Such expenses do not qualify because qualified leave wages are intended to replace wages or compensation that an individual would otherwise earn, rather than to serve as payments to offset any particular expenses that an individual would incur due to COVID-19 or any other qualified disaster. Additionally, qualified disaster relief payments do not include payments for expenses that are otherwise paid for by insurance or other reimbursement.
The IRS has not issued any guidance specific to COVID-19 as to what types of expenses may qualify under Section 139. Historically, these types of payments were straightforward because they were in response to a natural disaster such as property damage resulting from Hurricane Sandy, for example. Nevertheless, the underlying purpose of Section 139 suggests that there are several categories of reimbursable “reasonable and necessary expenses” implicated by the COVID-19 pandemic. These categories include:
- Medical expenses not covered by insurance (i.e. co-pays for testing, over-the-counter medicines relating to treatment of COVID-19);
- Health-related expenses such as hand sanitizers and disinfectant;
- Additional dependent care expenses (i.e. tutoring expenses, alternative child care expenses due to school closures)
- Work from home expenses (i.e. costs incurred to set up a home office including computer, printer, extra phone lines or phones, expanded internet bandwidth costs, installation of internet in some cases, and increased utility costs);
- Transportation expenses due to closure of public transportation;
- Caregiver and domestic services expenses;
- Funeral expenses; and
- Legal and accounting expenses.
Establishing a qualified disaster relief payment policy
While not required by Section 139, employers should consider adopting a written policy to provide guidance and set parameters for qualified disaster relief payments. Although the COVID-19 pandemic may be the immediate impetus behind the development of such policies, employers should look beyond the immediate crisis when drafting such policies. The policy should convey at least the following types of information to employees:
- the definition of a qualified disaster relief payment;
- the definition of a “qualified disaster”;
- what employees are eligible for such payments;
- the procedure for requesting payments including what employees will need to submit;
- a list of the types of expenses covered and those not covered;
- the process for reviewing requests for payment and whether there will be a limit on the amount of payments;
- the name and contact information for the person administering the program; and
- how payments will be made (reimbursement or vendor direct).
The policy should also reserve the right of the employer to modify, amend and/or terminate the program at any time and in their sole discretion. Section 139 of the Code does not require receipts or other proof of expenses incurred by employees. This does not mean, however, that employers cannot require the submission of receipts as part of the procedure for requesting payments.
In addition, employers may want to consider developing a questionnaire, specific to COVID-19, to provide to employees seeking to receive qualified disaster relief payments. The questionnaire should include questions like:
- Have you or a household member been exposed to COVID-19 or diagnosed with COVID-19?
- What changes to your lifestyle have you experienced because of the COVID-19 pandemic?
- What sort of insurance do you have?
- Have you spoken with your insurance agent about coverage?
- Are the expenses associated with medical costs or other expenses covered by your policy?
Employers should view this situation as an opportunity to provide, tax deductible, tax-free assistance as an additional benefit to their employees. Taking advantage of qualified disaster relief payments is a way for employers to encourage employees to return to work despite new challenges and expenses and a way to build good will and help employees during this challenging time.