Are your employees struggling with unexpected medical, work-from-home, childcare or other expenses as a result of the COVID-19 pandemic? If so, a little-known tax law allows you to make tax-free payments to employees to help them cover these expenses. Under Internal Revenue Code Section 139, qualified disaster relief payments — including payments by employers — are excludable from the recipient’s gross income, exempt from FICA and other payroll taxes, and deductible by the employer as ordinary and necessary business expenses.
Disaster relief is often associated with hurricanes, floods and other natural disasters. But in March 2020, pursuant to the Stafford Act, the President declared the pandemic a major disaster, thereby authorizing tax-free relief under Section 139.
What Types of Expenses Are Eligible?
Qualified disaster relief payments eligible for tax-free treatment include:
- Reimbursements or direct payments for reasonable and necessary personal, living or funeral expenses incurred as a result of a qualified disaster; and
- Reimbursements or direct payments for reasonable and necessary expenses to repair or rehabilitate a personal residence, or repair or replace its contents, on account of a qualified disaster.
The IRS has not provided any COVID-19-specific guidance on eligible expenses, but likely examples include:
- COVID-19-related health expenses not covered by insurance, such as copays, over-the-counter medications, masks, hand sanitizer and cleaning products.
- Work-from-home expenses, such as office furniture, computers, printers, phone service, supplies, higher-speed internet service and increased utility costs.
- Increased child-related expenses on account of school closings or remote learning requirements, such as childcare, tutoring, computer equipment, internet access and online educational resources.
- Expenses necessitated by known exposure to COVID-19, such as temporary housing, food delivery or home sanitization services.
- Critical care or funeral expenses for an employee or family member stricken with COVID-19.
Certain payments are ineligible, including expenses reimbursed by insurance or other sources, payments that constitute compensation (e.g., lost wages or sick pay) and payments for nonessential or luxury items.
Have a Plan
Because it is designed for disaster relief, Section 139 does away with many of the formal administrative requirements that apply to other employee benefits, such as preparing a written plan and conducting nondiscrimination testing. And employers need not require employees to submit receipts or other proof of their expenses, so long as the payment amounts are “reasonably expected to be commensurate with” the actual expenses incurred.
Despite this informality, if you wish to provide employees with COVID-19 relief, it is a good idea to prepare a written policy in order to manage employee expectations, establish guidelines and procedures and avoid fraudulent claims. The policy should, at a minimum, outline (1) which employees are eligible (being careful to avoid potential discrimination claims); (2) the types of expenses that may be paid or reimbursed; (3) limits, if any, on the amount of payments or reimbursements; (4) procedures for applying for relief; and (5) how and when payments will be made. Although not mandatory, it is advisable to require employees to submit receipts or other proof of their expenses. At the very least, you should have employees sign a written certification that the money received is necessary for COVID-19-related expenses and that those expenses are not otherwise reimbursable.
Related Read: Small Business Administration Disaster Loans
Qualified disaster relief payments can be a great way to help employees through this challenging time. Unfortunately, now may not be an ideal time to introduce benefits, especially if you are operating with a reduced staff or remote workforce. If you are considering offering these benefits, start by contacting your existing HR or payroll service providers. Many of these providers are now equipped to facilitate qualified disaster relief payments.