Thinking Outside the Box - Tax-Free Reimbursements during pandemic
As your practice continues to deal with the unprecedented COVID-19 pandemic, many employees may experience financial hardship and/or struggle to find childcare. One way you can provide assistance to employees impacted by the COVID-19 pandemic is by making tax-free “qualified disaster relief payments” under Code section 139. Qualified disaster relief payments are attractive to employers because they are both excludable from employees’ incomes and deductible by the employer – which is in the “win-win” category.
Below we briefly summarize the rules that apply to these payments, the types of permissible expenses that an employer can pay, and how employers can adopt these programs.
What Is a Qualified Disaster Relief Payment?
A qualified disaster relief payment is a payment to or for the benefit of an employee “to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster.” A “qualified disaster” includes a federally declared disaster, which now includes the COVID-19 pandemic. The IRS has confirmed that COVID-19 pandemic is a disaster for this purpose.
Since Code section 139 was written for natural disasters like hurricanes and wildfires, there has been limited IRS guidance on how the Code section 139 rules apply in the context of the COVID-19 pandemic so keeping it simple is advised.
What Type of Expenses Are Covered?
The expenses must be incurred “as a result of” the COVID-19 pandemic. IRS guidance in the context of other qualified disasters (ie - Hurricane Katrina) have permitted the payment/reimbursement of the costs of travel/transportation, lodging/temporary housing, meals, medical expenses, and incidental expenses incurred as a result of the disaster. In the context of COVID-19, some permissible expenses may include:
Travel and parking at the office if the employee is driving to work to avoid taking public transportation.
Lodging if the employee or a family member has to stay at a location besides his/her home to avoid a family member who has been diagnosed with COVID-19.
Child care cost if it allows the employee to continue to work while their children are home from school.
Medical expenses.
Funeral expenses if the employee or a relative passes away due to COVID-19.
Protective items, such as hand sanitizer, face masks, and gloves.
What Expenses Are Not Covered?
You can not pay any expenses for which the employee is compensated for by insurance or otherwise. Additionally, the payments can not be a replacement for lost wages, sick leave or other paid time off.
How Can an Employer Make the Payments?
You can make the payments directly to employees via the employee’s paycheck. The disaster-related payments should be reimbursed on an expense-by-expense basis (up to a pre-determined limit).
Are There Any Substantiation Requirements?
Unbelievably, the IRS does not have an express substantiation requirements for these payments. However, we recommend that you document the payments by using a Disaster Relief Payment form that employees will complete and return with related receipts.
How Does an Employer Offer These Benefits?
You will need to adopt a written policy that outlines the program requirements, the types of expenses are covered, and the administrative process and restrictions. This is helpful not only in the event of an IRS audit, but also to communicate the requirements to your employees.
For How Long Can an Employer Make the Payments?
An employer can make the payments until the President declares that the COVID-19 pandemic is no longer a qualified disaster – that is at least through end of 2020 if not further.