As the COVID-19 pandemic continues to substantially affect companies and their workforces, employers are considering ways to help employees with the financial burdens that employees and their family members may experience as a result of the pandemic.
Disaster relief payments — permitted under Section 139 of the U.S. Internal Revenue Code (the Code) — offer employers a flexible and potentially tax-free method to reimburse employees for certain qualifying expenses incurred as a result of COVID-19. Specifically, any payments made to employees that satisfy the requirements of Section 139 of the Code are deductible to employers but not subject to federal income or employment taxes. Such payments could, however, remain subject to state and other non-federal taxation.
This Sidley Update briefly summarizes the applicable provisions of Section 139 of the Code and highlights design considerations for employers who may be considering disaster relief payments in connection with COVID-19.
Overview – Disaster Relief Payments Under Section 139 of the Code
Section 139 of the Code generally provides that “qualified disaster relief payments” made by an employer to an employee are excluded from gross income and are not subject to any federal payroll taxes. “Qualified disaster relief payments” are generally defined as 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” (within the meaning of Section 165(i)(5)(A) of the Code), provided that such expense is not covered by insurance or otherwise compensated or reimbursable. Based on Notice 2020-18 from the Internal Revenue Service (IRS) delaying the April 15 due date for the filing of federal income tax returns and payments for all U.S. taxpayers, it appears the IRS has determined that COVID-19 constitutes a “qualified disaster” under Section 165(i)(5)(A) of the Code, thus opening the door for employers to offer employees “qualified disaster relief payments” in connection with COVID-19.
While Section 139 of the Code does not impose limits on qualified disaster payments that employers may make to employees (either individually or in the aggregate), any payment to replace wages or salary does not qualify under Section 139 of the Code.
Qualified disaster payments are not required to be reported or disclosed by employers or employees, including via Form W-2 or 1099, and they are not subject to federal tax withholding obligations.
Considerations for Employers Providing COVID-19 Qualified Disaster Payments
Although Section 139 of the Code does not require employers to adopt a written plan or policy to make qualified disaster payments, employers who desire to make qualified disaster payments on account of COVID-19 should consider, as a best practice, establishing a written plan or policy. Such plan or policy would communicate, at minimum, the following information to employees: (1) who is eligible for such payments; (2) what expenses will be reimbursed or paid and whether there are limits on the amount of reimbursements or payments; (3) whether employees must provide receipts or other proof of their expenses to the employer to be eligible for payments; and (4) how and at what time payments are made.
Section 139 does not require receipts or other proof of expenses incurred by employees and the IRS previously issued guidance clarifying that individuals are not required to account for actual expenses to qualify for the Section 139 exclusion, provided that that the amount of payments can be reasonably expected to be commensurate with the expenses incurred. However, employers should consider whether they wish to do so in order to control costs or to avoid fraudulent claims from employees. Absent such concerns, a carefully designed plan or policy (e.g., with specified types of expenses reasonably expected to be incurred and related limits), combined with a certification by the applicant that they have in fact incurred such expenses, may be sufficient to mitigate any risks to employers of not requiring employees to submit supporting documentation.
Although the IRS has not issued guidance specific to COVID-19 as to the types of expenses that may qualify under Section 139, listed below are some examples of the types of expenses (to the extent reasonable and necessary) that an employer could consider including in a plan or policy adopted in connection with COVID-19:
- unreimbursed COVID-19 medical expenses (e.g., copays incurred for COVID-19 treatment or over-the-counter medications used to treat COVID-19);
- work-from-home expenses (e.g., costs to create home office, such as purchasing a printer or home phone; increased utility costs on account of the home office; cost of new or expanded internet access);
- dependent care expenses (e.g., increased child care or tutoring costs due to school closings; remote learning or home schooling expenses, such as home internet, computer for use by a dependent, educational materials, subscriptions to online educational resources, etc.);
- increased transportation expenses (e.g., increased commuting costs from lack of access to public transportation);
- funeral expenses (e.g., expenses attributed to the funeral of an employee, his or her spouse or dependent, who dies from a COVID-19 infection); and
- other living expenses on account of an employee’s known exposure to COVID-19 (e.g., cleaning products to sanitize home, etc.).
Employers interested in adopting a COVID-19 disaster relief program also should consider other aspects of implementing such a program, including but not limited to (i) administrative complexity at a time when staffing may be decreased or remote, (ii) costs given the potential for widespread participation in the program by employees, (iii) privacy considerations, particularly if documentation is requested by the sponsoring employer, and (iv) tax consequences under state and other non-federal laws.
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