Qualified Disaster Relief Payments: A Win-Win for Employers & Employees

A little-known provision of the tax code, Section 139, allows employers to make qualified disaster relief payments to employees – payments that are both tax-free to the employees and deductible to the employer. The IRS has confirmed that the COVID-19 pandemic qualifies for relief under this provision in all 50 states, the District of Columbia, and all U.S. Territories, as a result of President Trump’s emergency declaration under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

How It Works

• Eligible recipients include not just employees but any other individuals, including directors, consultants, independent contractors, etc.
• Qualified disaster relief payments are neither subject to federal income tax nor payroll taxes for the recipient, and are not reportable on Form W-2 or Form 1099. They are also exempt from income taxes in many states, including Maryland.
• Qualified payments are fully deductible by the payer company as an employee benefit expense.  There is no dollar limit to the amount that can be paid to employees tax-free or deducted by the employer, and no coverage or non-discrimination requirements.

Eligible Expenses
Under Section 139 of the tax code, qualified disaster relief payments include reimbursements or payments of “reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster” (such as COVID-19). Such expenses do NOT have to be related to the individual’s employment with the company. While no official guidance is currently available on qualifying expenses for this specific situation, examples of potentially eligible expenses (not an exhaustive list) include:

• Medical expenses and over-the-counter medications related to COVID-19 not compensated for by insurance
• Funeral expenses of employees or family members passing away from COVID-19
• Costs to purchase personal protective equipment such as masks, gloves, hand sanitizer, etc.
•  Dependent care or tutoring expenses incurred due to COVID-related closures of schools, daycares, camps, etc.
• Costs to establish a home office, and increased costs associated with maintaining an existing home office (computer, cell phone, supplies, printer, increased Internet & utility costs, etc.)
• Housing costs incurred due to isolation or quarantine requirements
• Costs of forms of commuting used as a safer alternative to mass transit
• Potentially, certain costs associated with permanently relocating an employee due to COVID-19

Non-Qualifying Payments
Most significantly, this favorable tax treatment does NOT apply to any qualified wages, or to payments intended to replace compensation or lost income.  Qualified sick pay and qualified family medical leave, for example, are not eligible for the Section 139 treatment, and thus are taxable to employees.  Also, payments reimbursed by insurance, or payments for expenses considered excessive or non-essential, are ineligible.

How to Set it Up
Surprisingly, Section 139 does not currently require a formal plan or specific documentation to be maintained by the employer.  However, for employers wishing to take advantage of the tax benefits available for qualified disaster relief payments, we recommend adoption of a written policy.  At a minimum, a formal Section 139 plan should include the following:

• Start and end dates for the program
•  Individuals eligible to participate (limited to employees?)
• A list of the types of expenses eligible for reimbursement by the company
• Specification of required documentation to be provided by participating employees
•  Maximum payment amount per employee, and possibly in aggregate (set by the company)
• A mechanism to track amounts paid on behalf of each individual employee

If you have questions or concerns on how these new provisions may impact your situation, please contact your KatzAbosch representative.