The impact of the COVID-19 outbreak is dynamic and widespread, with both employers and their employees having to work in completely different environments than they did at the beginning of the year. Because of the unprecedented situation, a disaster was declared nationwide. For employers, this may present a relief option for their employees – many of whom now operate under remote, work-from-home situations and are balancing childcare disruptions. In this article, we explain how qualifying employers can help mitigate the effects through tax-deductible qualified disaster payments to employees.
What is a Qualified Disaster, and Does It Apply to COVID-19?
Internal Revenue Code Section 139 allows an individual to exclude qualified disaster relief payments from gross income and payroll taxation. The law was originally enacted in 2001 as relief to victims of terrorist acts, but remains in effect as relief for victims of natural disasters as well.
Typically, qualified disaster relief payments are offered in response to local or regional disasters like hurricanes or floods. The Code includes any disaster determined by the President to warrant assistance under the Robert T. Stafford Disaster Relief and Emergency Act, and such a disaster was declared nationwide in connection with the COVID-19 pandemic (March 13, 2020).
What is a Qualified Disaster Relief Payment?
A “qualified disaster relief payment” is defined by section 139(b) of the Internal Revenue Code to include any amount 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.
Qualified disaster relief payments do not include qualified wages paid by an employer, even those that are paid when an employee is not providing services.
As a result, if your company makes qualified payments to employees in the U.S. who have incurred qualifying expenses due to the COVID-19 pandemic, those payments should not be subject to income tax withholding, FICA, or FUTA, and should not have to be reported on employees’ W-2 forms.
How Can Employers Use the Qualified Disaster Relief Payment to Benefit Its COVID-19 Impacted Employees?
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
- Additional travel/food expense for a returning student
- 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
- Temporary housing
- Payments for lost income or compensation (e.g., wages, sick pay, family medical leave pay, etc.)
- Nonessential items, luxury items, decorative items and services (e.g., Netflix subscription)
- Items covered by insurance or other sources
How To Document 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.
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.