We Take Care of Our Own: How to Provide Tax-Free Financial Assistance to Employees during COVID-19

The COVID-19 public health crisis has created a wave of unprecedented financial uncertainty. Fortunately, opportunities exist for employers to provide tax-free financial assistance to employees who are facing economic hardship or who have otherwise been impacted by the virus. As described below, employers can provide this financial assistance directly or through a related charitable organization.

Code Section 139 Qualified Disaster Relief Payments

As a general rule, all payments made from employers to employees constitute taxable income.  However, the President’s recent national emergency declaration under the Robert T. Stafford Disaster Relief and Emergency Assistance Act (the “Presidential Declaration”) created an important exception to that rule. Under Code Section 139, the Presidential Declaration means employers can make “Qualified Disaster Relief Payments” directly to employees impacted by the virus. If structured properly, these payments are not included in the gross income of the employees, but employers can still deduct these payments as ordinary business expenses. Moreover, the unemployment benefits available to employees will not be affected by Qualified Disaster Relief Payments.

Qualified Disaster Relief Payments include any amount paid to reimburse or to pay for reasonable and necessary personal, family, living or funeral expenses incurred because of the virus. These payments are designed to include expenses such as: temporary housing costs, unreimbursed health care costs, increased childcare or tutoring expenses, costs for medical supplies, transportation costs, home office expenses and any other costs the employee would not have incurred but for the COVID-19 outbreak. Payments cannot be made for expenses to the extent they are otherwise covered by insurance. Additionally, payments cannot be made as a form of wage replacements, as those payments would be subject to income tax.

Fortunately, the federal guidance is clear that employers are not obligated to require employees to account for the actual use of the payments. Thus, employers have wide flexibility in administering a Qualified Disaster Relief Payment program. Employers can design programs with strict substantiation requirements that require proof of valid expenses prior to making payments. Alternately, employers have the freedom to simply grant all employees a lump sum Qualified Disaster Relief Payment designed to cover current and anticipated expenses attributable to the virus. Notably, financial need is not a requirement under Code Section 139, meaning all employees, even those who are highly compensated, may receive Qualified Disaster Relief Payments without demonstrating economic hardship. 

To receive the favorable tax treatment above, a Qualified Disaster Relief Payment program must be structured properly and administrated consistently. Based on IRS guidance, before making these types of payments, an employer should adopt a Qualified Disaster Relief Payment policy that details the guidelines the company will use in administering the payments, including clear eligibility requirements, information on the types of expenses covered by the program and what factors (if any) will be used in selecting payment recipients. Ice Miller is currently working with employers of all sizes to implement Qualified Disaster Relief Payment programs.

Related Charitable Foundation

In the midst of this economic uncertainty, employers do not have to rely on company revenue to provide relief to employees. Instead, as described below, companies have the ability to leverage charitable dollars to help employees facing hardship.

Throughout the United States, companies often create charitable foundations under Section 501(c)(3) of the Internal Revenue Code (the “Code”) to advance corporate social responsibility initiatives and increase employee engagement. At a high level, these foundations are designated as either “private foundations” (a foundation funded primarily by the company and not individual employee contributions) or a “public charity” (a foundation funded primarily through employee or public contributions). 

Under federal tax rules, public charities have traditionally been permitted to operate employee relief funds (“Relief Funds”) that receive tax-deductible charitable contributions and then grant those dollars to employees experiencing any form of financial or personal hardships. If the Relief Fund is operated pursuant to IRS guidelines and subject to a board-adopted policy, Relief Fund grants are tax-free to employees and not subject to withholding, reporting or other employer obligations.

Historically, private foundations have been prohibited from operating Relief Funds. However, pursuant to the Presidential Declaration and subject to Code Section 139, private foundations can now operate Relief Funds for the limited purpose of supporting individuals impacted by the virus, and they may do so without seeking advance approval from the IRS. Unlike public charities, private foundations cannot provide financial support for other types of hardships.  Whether operated by a public charity or a private foundation, Relief Funds require the employee to show “financial need” as defined in the policy in order to qualify for a grant from the fund.

A group of employers may consider jointly setting up a single Relief Fund for all their employees. With several corporate donors, a joint Relief Fund could more easily obtain public charity status and thus facilitate a more comprehensive hardship relief program and meet the broader needs of team members than just the virus. 
If an employer has an existing related charity in place, the charity can create a Relief Fund by formally approving the creation of the program and adopting the policies, guidelines and other ancillary documents (e.g., application, financial needs assessment) necessary to facilitate the program.

If an employer does not have an existing charity, establishing a Relief Fund can still be a relatively quick process. With the right legal counsel, creating a charity to operate a Relief Fund can be done in a matter of days. While the federal tax exemption process is lengthy, a charity’s IRS tax exemption determination is retroactive to the day the charity was formed. Thus, a charity may begin operating its Relief Fund immediately after being incorporated.

Ice Miller’s COVID-19 Taskforce continues to work with employers of all sizes to identify strategies to support employees during this challenging time. If you would like to learn more about creating a tax-exempt charitable Relief Fund or establishing a Qualified Disaster Relief Payment program, please contact Gina Giacone, Ryan Waggoner, Sterling Shown, Matt Ehinger or another member of the Ice Miller Team. 

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.