With the COVID-19 pandemic declared a national emergency, employers might be able to use qualified disaster relief payments to provide financial assistance to employees who are impacted by the ongoing disruption.
These payments won’t count toward the employees’ gross income; however, there are many factors employers should consider and it’s important to note that not all payments will qualify.
Below, we outline the types of expenses these payments might be able to cover, as well as important provisions for how employers with corporate foundations and employer-sponsored public charities or donor-advised funds should structure payment distributions.
Background
When President Trump declared a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act of 1988, the pandemic was designated as a qualified disaster for employee relief payments. Internal Revenue Code (IRC) Section 139 excludes any qualified disaster relief payments from an individual’s gross income.
This means qualified payments, even when made by an employer, aren’t subject to:
- Income tax
- Self-employment tax
- Employment taxes, such as Social Security, Medicare, and federal unemployment taxes
Qualified Expenses
A qualified disaster relief payment is defined as any amount paid to an employee as a result of a qualified disaster for any reasonable and necessary personal, family, living, or funeral expenses, and for any reasonable and necessary expenses to repair or rehabilitate a personal residence or its contents. There’s no dollar limit on the payments.
If payments are deemed unreasonable, however, the excess will be included in an employee’s gross income and wouldn’t be deductible to the employer.
The IRS hasn’t issued specific guidance on the types of expenses related to COVID-19 that may qualify as disaster relief. Examples could potentially include:
- Unreimbursed COVID-19 medical expenses
- Work-from-home expenses
- Dependent-care expenses, including child care and additional educational expenses related to remote learning
- Additional transportation expenses
- Funeral expenses
Payments that replace lost wages, lost business income, or unemployment compensation, or that are reimbursed by insurance, aren’t qualified disaster relief payments.
Documentation by the employer is required to treat the payments as disaster relief payments. The IRS hasn’t issued specific guidance on documentation, but has said that employer programs should have requirements to ensure that the amounts granted are commensurate with the disaster-related expenses incurred.
Although not explicitly required, employers should consider adopting a written policy on making qualified disaster payments as a best practice. Such a policy could include:
- Eligibility requirements
- Types of expenses that will be reimbursed
- Any limits on reimbursements
- Proof required by employees
- Designations of how and when payments are made
Given the lack of detailed documentation requirements, substantiating the employee income exclusion could create uncertainties for employers. In addition, the determination of if an expense is reasonable and necessary is subjective and open to challenge.
Corporate Foundations
The designation of COVID-19 as a qualified disaster also allows corporate foundations to make disaster-relief payments to employees of the corporate sponsor.
When making these grants, however, corporate foundations are still subject to the IRC rules on self-dealing, taxable expenditures, and minimum distributions.
Corporate foundations and other employer-sponsored private foundations must ensure the grants serve a charitable purpose, instead of the business purposes of the sponsoring employer.
Payment Requirements
The IRS will presume that qualified disaster relief payments made to employees, or family members of employees, of the employer sponsor serve the foundation’s charitable purpose if all of the following are true:
- The class of beneficiaries is large or indefinite.
- The recipients are selected based on an objective determination of need.
- The selection of recipients is made by an independent committee, or other procedures are in place to ensure that any benefit to the employer is incidental. A selection committee is independent if a majority of members are people who aren’t in a position to exert substantial influence over the employer’s operations.
Grants can’t be made to people who are directors, officers, or trustees of the private foundation, or to members of the selection committee. Employer-sponsored private foundations can only make payments to employees affected by qualified disasters; payments for nonqualified disasters or other hardships aren’t allowed.
The IRS has noted that these criteria are only a presumption. A corporate foundation that doesn’t meet all three requirements could still qualify for making disaster relief payments. A foundation that does meet the criteria could still be subject to a review to ensure that any benefit to the employer is minimal.
Employer-Sponsored Public Charities
Public charities don’t face the same restrictions on self-dealing and taxable expenditures as private foundations.
An employer can set up a public charity to provide assistance to employees for any type of disaster or hardship—not necessarily a qualified disaster—as long as the employer sponsor doesn’t exert excessive control over the public charity.
Still, according to IRS Publication 3833 Disaster Relief: Providing Assistance Through Charitable Organizations, the public charity’s grant program should follow the same criteria as outlined above for private foundations.
Employer-Sponsored Donor-Advised Funds
Donor-advised funds (DAFs) are usually set up by individuals at community foundations or other public charities; the individual donors have advisory privileges over the granting of funds.
Generally, DAFs can only make grants to 501(c)(3) public charities, and not to individuals. There’s an exception for employer-related funds or accounts set up to benefit employees and family members who are victims of a qualified disaster.
According to IRS Publication 3833, a DAF can make qualified disaster relief payments, under the following criteria:
- The fund serves the sole purpose of providing relief from one or more qualified disasters
- The fund serves a charitable class
- Recipients are chosen based on an objective determination of need
- The selection of recipients is made by an independent selection committee, or procedures are set up to ensure that any benefit to the employer is incidental
- No payment is made to benefit any director, officer, or trustee of the sponsoring public charity, or members of the selection committee
- The fund maintains records of the recipients’ need for disaster relief
We’re Here to Help
To learn more about how your organization might make disaster relief payments to employees and the issues you need to address if you are considering such payments, contact your Moss Adams professional.