Due to COVID-19, President Trump recently declared a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act (the Stafford Act), thereby opening up the opportunity for employers to provide tax-free assistance to employees under Section 139 of the Internal Revenue Code.
Code Section 139 provides that qualified disaster relief payments from any source, reimbursing or paying an individual for certain expenses in connection with a qualified disaster, are not subject to income or employment taxes (Social Security, Medicare and federal unemployment taxes).
Qualified disaster relief payments include any amount paid by an employer to, or for the benefit of, an employee to reimburse or pay reasonable and necessary expenses incurred as a result of a qualified disaster. The expenses that qualify are for personal, family, living or funeral expenses.
The IRS cited this legislative history and ruled that employer grants to employees to cover medical, temporary housing and transportation expenses incurred as a result of a presidentially-declared disaster (which are not reimbursed through insurance or otherwise) are excludable from income, even though the employees are not required to provide proof of actual expenses to receive a grant. The IRS indicated the employer program contains requirements to ensure the grant amounts are reasonably expected to be commensurate with the amount of unreimbursed reasonable and necessary medical, temporary housing and transportation expenses incurred.
Qualified disaster relief payments within the meaning of Section 139 includes payments received (regardless of the source) for the following expenses that resulted from a qualified disaster:
- Reasonable and necessary personal, family, living or funeral expenses
- Reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence (a personal residence can be a rented residence or one you own); and
- Reasonable and necessary expenses incurred for the repair or replacement of the contents of a personal residence. Payments by a federal, state or local government, or their agencies or instrumentalities, to persons affected by a qualified disaster to promote general welfare are also considered qualified disaster relief payments. For purposes of such payments, a qualified disaster includes the events listed above, as well as a disaster determined by a federal, state or local authority to warrant governmental assistance.
Reimbursable Expenses Implicated by COVID-19
Qualified disaster relief payments, however, do not include: (i) payments for expenses that are otherwise paid for by unemployment insurance or other reimbursements; or (ii) income replacement payments, such as the payment of lost wages, lost business income or unemployment compensation.
It is unclear what types of expenses may be reimbursed tax-free during a pandemic (versus a natural disaster), but Section 139 suggests there are several categories of reimbursable expenses that are a result of the COVID-19 pandemic, including:
- Medical expenses not covered by insurance (e.g., copays, deductibles, over-the-counter medicines and cleaning supplies);
- Childcare and tutoring expenses;
- Employee home office expenses (e.g., laptop, printer, supplies, internet service costs.);
- Commuting expenses
- Caregiver and domestic service expenses
- Funeral expenses
- Legal and accounting expenses
Note that wage replacement (such as paid sick or other leave) is not covered by Section 139, so such payments would still be taxable wages and would remain subject to income- and payroll-tax withholding and reporting. Payment of rent that is the result of wage reduction, furlough or termination is not a qualified payment.
Written Programs Can Be Helpful
Although there is no requirement for the employer to have a written qualified disaster relief payment plan, employers should consider establishing procedures to inform employees of the reimbursement process and for collecting and reviewing requests for relief.
Revenue Ruling 2003-12, "described a situation where the employer did have a written program and the IRS favorably concluded the payments would meet the criteria for income tax exclusion. Furthermore, the employer may wish to inform employees as to the details of the employer system of reimbursement," which could be accomplished through a written plan.
Several resources suggest employers:
- Clearly state that the program is related to the COVID-19 national emergency
- Describe eligible employee classes or groups
- List expenses that will be reimbursed, or provide a per-employee allowance for presumed reasonable expenses
- Describe the method for reimbursement or payment
- Provide any employer-imposed expense limit per employee (no limit applies per the statute)
- Name the administrator and define the administrator's powers, such as discretionary decisions
- Provide the start and end date of the program
Good Program Governance
Although Section 139 programs are not subject to the Employee Retirement Income Security Act (ERISA), it may be prudent for an employer to follow and apply ERISA principles in administrating its program, as a good practice to ensure the program is applied uniformly.
The coronavirus pandemic is the type of disaster for which an employer may reimburse employees for disaster-related expenses on a tax-free basis, free from Form W-2 or 1099 reporting. Generally, state treatment for income-tax withholding purposes will mirror the federal treatment of qualified disaster relief payments.
California complies with IRC Section 139, as to the tax-free nature for qualified disaster mitigation payments (as defined by Section 139 of the IRC, made by an employer before, on or after April 15, 2005). These payments are not subject to PIT withholding or reportable as PIT wages under Sections 13006, 13009(q) and 13009 of the CUIC. However, disaster mitigation payments paid by employers are subject to UI, ETT and SDI.
The payments made to an employee must reimburse or pay for qualified expenses that resulted as a result of the coronavirus pandemic.
BPM’s tax specialists are here to help. To learn more, contact Robert Houston at [email protected].