Alert

Businesses can help ease the financial burden on employees who have been affected by the California wildfires and other federally declared disasters while benefiting from favorable tax treatment by utilizing Internal Revenue Code (IRC) Section 139.

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

What is a Qualified Disaster Relief Payment?

A qualified disaster relief payment is defined as any amount paid to an affected employee 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.

Employers can deduct the payments as a business expense, provided they are reasonable and meet the criteria for qualified disaster relief. If payments are deemed unreasonable, however, the excess will be included in an employee’s gross income and won’t be deductible to the employer.

Qualified disaster relief payments can include (but are not limited to) amounts paid for:

• Temporary housing or rent
• Food and clothing
• Medical expenses not covered by insurance
• Repairs and renovations of a primary residence

Payments that replace lost wages, lost business income, or unemployment compensation, or that are reimbursed by insurance, aren’t qualified disaster relief payments.

How to Document 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 whether an expense is reasonable and necessary is subjective and open to challenge.

Employers that are Charitable Entities

Employers that are tax-exempt entities who are considering disaster relief payments to employees should consult with their attorney, tax advisors, and governing body when implementing a disaster relief policy. It’s critical to evaluate whether such payments are permissible under the organization's charitable purpose and guidelines for the use of charitable funds. Furthermore, if payments are being considered to any disqualified person, additional steps should be taken to ensure that the payments are not excess benefit transactions.

Charitable entities classified as 501(c)(3) organizations Hare permitted to provide support to a group of individuals so long as that individual is considered a “charitable class”. A charitable class must be large enough or sufficiently indefinite that the community, rather than a pre-selected group of people, benefits when a charity provides assistance. If the group of eligible beneficiaries is limited to a smaller group, such as the employees of a particular employer, the group of persons eligible for assistance must be indefinite.

To be considered to benefit an indefinite class, the proposed relief program must be:

• Open-ended
• Include employees affected by the current disaster and who may be affected by a future disaster

Therefore, if a charity follows a policy of helping employees who are victims of all disasters, present or future, it would provide assistance to an indefinite charitable class. If a charity’s facts and circumstances indicate that its newly established disaster relief program is intended to benefit only victims of a current disaster without intending to help victims of future disasters, the organization wouldn’t benefit a charitable class.

Use Discretion in Fund Distribution

Furthermore, if a charitable entity is accepting donations to assist employees or individuals impacted by a disaster, the organization should ensure that funds are not earmarked for or flow directly to impacted individuals. A charitable organization, when using discretion to distribute funds, must consider:

• Its charitable purposes
• The public benefit of its activities
• The specific needs and resources of each victim

Under federal law, qualified tax-exempt charities should have full control and authority over the funds donated to them. Contributors may not earmark funds for the benefit of a particular fund or family. They may, however, earmark the funds for a more general purpose such as disaster relief or fire relief in this case.

Next Steps

• Review IRS Guidelines. Ensure you are fully informed about available relief options and eligibility requirements.
• Support Your Employees. Consider implementing a disaster relief assistance program to provide meaningful support to your team.

We’re Here to Help

For assistance with IRC 139 compliance or navigating the challenges posed by the recent wildfires, contact your Moss Adams professional.

Additional Resources

• State & Local Tax Services
• Tax Services