With President Trump having issued an “emergency declaration” related to the COVID-19 pandemic, the IRS delayed tax season until July 15th by relying on Section 7508A(a) of the Internal Revenue Code, which can only be done when there is a “federally declared disaster” pursuant to Code Section 165.
By taking the position that the President’s emergency declaration amounts to a federally declared disaster under Section 165, the IRS opens the door for employers to provide certain benefits to employees impacted by COVID-19 in the form of “qualified disaster relief payments.” These payments will be tax-free to the employee, but fully deductible by the employer.
What types of tax-free payments may be made to employees?
Section 139 allows for tax-free payments to reimburse or pay the employee for the following expenses that are not otherwise compensated for by insurance:
- Reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster, and
- Reasonable and necessary 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.
Specific to COVID-19, presumably, an employer could make the following types of payments to employees on a tax-free basis, while still deducting the payment:
- Medical expenses not compensated for by insurance related to COVID-19;
- Other health-related expenses including over-the-counter medication or hand sanitizer;
- Funeral expenses of the employee’s family as a result of COVID-19;
- Child care for workers whose normal source of child care is unavailable due to COVID-19;
- Tutoring expenses for employees’ children; and
- Increased telecommuting costs such as computers, printers, or supplies.
Section 139 payments do NOT include items intended to replace lost income; thus, for example, sick pay would be fully taxable to the employee.
What employees are covered?
The payments may be made to all of a company’s employees, regardless of how long they have worked there, and there is no cap on the amounts that can be paid to any individual employee or to all employees in the aggregate.
Is a formal plan required?
The statute requires no formal written plan, and at this time, there are no regulations interpreting Section 139. However, RubinBrown recommends an employer maintain the following documentation when making Section 139 payments:
- A description of every eligible employee class;
- A list of the types of expenses that will be reimbursed;
- A description of the method for reimbursement/payment, e.g. whether application is necessary;
- Any employer-imposed limit to be paid to each employee or in the aggregate;
- The start and end date of the program.
As you might imagine, Section 139 has never before been utilized in response to a national pandemic; as a result, there is limited guidance as to how the provision applies to this type of disaster. If employers comply with the spirit of the provision, however, and reimburse employees for COVID-19 related costs not otherwise reimbursed by insurance, the payments should be fully deductible to the employer and tax-free to all employees.
By: Tony Nitti, CPA, MST
Readers should not act upon information presented without individual professional consultation.
Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.
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