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Section 139 Tax Favored Qualified Disaster Relief Payments for COVID-19 Related Expenses

The Coronavirus pandemic has changed everyday life for everyone, and employers may be looking to find a silver lining to assist employees who are directly impacted. The Internal Revenue Code (IRC) was amended in the wake of the September 11, 2001 attacks, providing a way an employer can make tax free “qualified disaster relief” payments to help employees as a result of a national disaster. Section 139 establishes a federal income exclusion for payments received related to a “qualified disaster.”

For Section 139 to apply, the disaster must be a qualified federal disaster. Once President Trump declared COVID-19 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 the COVID-19 pandemic is a qualified 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. The exclusion may apply to state taxes and state tax withholding as well, but employers should consult with their tax advisor.

Qualified disaster relief payments received by an employee can be excluded from gross income under the Internal Revenue Code Section 139.

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.

In previous disasters, like Hurricane Katrina and Sandy, it was clear that all the expenses related to property damage such as temporary housing, food, and property replacement would be covered. However, since COVID-19 is unique in the context that it is the first declared disease pandemic, there is little guidance for employers to determine what qualifies as a “personal, family, or living” expenses incurred as a result of COVID-19.

Based on the COVID-19 pandemic, employers may consider reimbursing or paying employees for “reasonable and necessary expenses” such as:

  • Medical expense not covered by insurance (e.g., copay for COVID-19 related expenses)
  • Health-related expenses (e.g., hand sanitizer, face masks, sanitizing cleaning products)
  • Dependent care expenses due to school/place of care closings
  • Tutoring and home-schooling related expense (e.g., Internet, computers to directly aid the education, online education applications)
  • Working from home expenses (e.g. home office set-up, internet, printer, cell phone costs)
  • 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
  • Counseling
  • 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.

For more information on evolving compliance regulations the wake of the COVID-19 pandemic, visit the OneDigital Coronavirus Advisory Hub, or reach out to your local OneDigital advisory team.