Qualified disaster relief payments received by an employee can be excluded from gross income under the Internal Revenue Code Section 139
Once President Trump declared COVID-19 and the Oregon Wildfires a national disaster under the Robert Stafford Disaster Relief and Emergency Assistance Act, and the IRS’s interpretation of the declaration for other tax purposes, it appears that these disasters qualify for federal disaster under Section 139. As a result, employers can assist employees with qualified disaster relief payments that are tax-free to employees and fully deductible to employers. This means that an employer can give their employees cash to help them through a disaster, and the employee does not have to pay income tax on that cash. These payments are excluded from gross income and wages and compensation for purposes of employment taxes. They are not subject to federal tax withholding and does not need to be reported on Form W-2 of Form 1099.
What qualifies as “qualified”?
To be excludable from income, an amount paid by an employer must be a “qualified disaster relief payment.” This term includes amounts 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; or
Expenses incurred for the repair or rehabilitation of a personal residence, or repair or replacement of its contents, to the extent that the need for such repair, rehabilitation, or replacement is attributable to a qualified disaster.
Employers may consider reimbursing or paying employees for “reasonable and necessary expenses” such as:
- Medical expense not covered by insurance
- Health-related expenses
- Dependent care expenses due to school/place of care closings
- Tutoring and home-schooling related expense
- Working from home expenses
- Incremental utility costs due to working from home
- Transportation expenses incurred as a result of public transportation terminations and/or work relocation
- Critical care or funeral expenses of an employee or their family due to COVID-19 or wildfires
- Temporary housing
- Non-perishable foods for reserve
- Additional travel/food expense for a returning student
What is excluded?
- Items covered by insurance or other sources
- Nonessential items, luxury items, decorative items and services (e.g., Netflix subscription)
- Payments for lost income or compensation (e.g., wages, sick pay, family medical leave pay, etc.)
Setting up a plan
Section 139 plans are not subject to the Employee Retirement Income Security Act (ERISA), and the guidance from the IRS does not require an employer to establish a written formal plan. However, a formal plan document is recommended. An IRS revenue ruling described a situation where the employee did have a written program and the IRS favorably concluded the payments would meet the criteria for income tax exclusion. And as best practice, a formal plan document will help inform employees as to the details of the employer system of reimbursement. In designing and drafting the plan, some key features to include are:
- Eligibility description for employees (e.g., classes or group)
- Although there is no formal nondiscrimination testing, appropriate eligibility parameters should be created)
- Owners can participate but disallow certain benefits if considered “double benefits”
- List of expenses that will be reimbursed
- “Reasonable and necessary”
- Any per employee limitations for presumed reasonable expenses
- Employers can cap the total amount of reimbursement, even though there is no statutory cap on the amount of assistance that may be provided
- Method of payment
- Reimbursement or vendor direct
- Beginning and end date of the program and expense occurrence
- Administrator, or internal committee, and administrator’s powers, such as discretionary decisions
- How employees will submit
- Statement that the program is with respect to the COVID-19 Outbreak Stafford declaration
Documentation of expenses
IRC Section 139 requires little or nothing in the way of recordkeeping or substantiation. However, an employer will still want to maintain adequate records to supports its deduction for the payments. Additionally, best practice would entail collecting receipts (if available), or written confirmation that an employee incurred qualified expenses, to avoid potential abuse.