The California wildfires have been horrifying to witness and, like many disasters, leave a long tail of hardship for those affected. As an employer, your instinct may be to implement a program to assist employees who need extra support during these difficult times. However, the last thing you want is to provide assistance only to have it taxed later.
The good news: the IRS outlines several tax-free ways to support employees during a disaster under Section 139 of the Internal Revenue Code.
Section 139: Tax-Free Relief Payments
First, it’s important to understand what qualifies as a “qualified disaster relief payment.” As an employer, you cannot provide tax-free gifts or support for personal misfortunes (such as a house fire or a sick child).
To qualify as tax-free under Section 139, the following criteria must be met:
- The disaster must be a federally declared disaster (as issued by the President of the United States), an act of terrorism, a military action, or another event the IRS deems catastrophic. (For example, on January 8, President Biden approved a major disaster declaration for California.)
- The payment must cover reasonable and necessary personal, family, or living expenses not covered by insurance.
- The payment cannot be wage replacement.
Employees are not required to provide detailed receipts to employers, as long as the expenses are reasonable and consistent with the expected costs incurred.
These payments are excluded from federal taxable wages (and may also be excluded from state taxes, depending on the state).
Under Section 139, both cash and in-kind benefits are permitted. This means employers can provide:
- Cash
- Certificates for food
- Temporary housing or hotel stays
- Medical care
- Clothing
- Other essential items related to evacuation or disaster damage
Retirement Plan Distributions
If your company sponsors a retirement plan and the disaster has been recognized by FEMA, you may allow distributions under SECURE Act 2.0 provisions as a Qualified Disaster Recovery Distribution (QDRD).
A QDRD can be up to $22,000 and offers the following benefits:
- Not taxed if repaid within 3 years
- Not subject to withdrawal penalties
- Taxed over three years instead of the year received
Retirement Plan Loans
The ability for employees to take loans from their 401K or retirement plan also increased under the Secure Act 2.0. The disaster provisions allow for an increase in the loan limit to the lesser of $100,000 or 100% of the employee’s vested balance. Furthermore, the loan repayment period can be extended up to an additional year for a loan existing at the time of the disaster or initiated because of the disaster.
Leave Donation Programs
During a disaster, time may be what an employee needs most severely. For a Leave Donation Program, employees NOT affected by the disaster donate their sick days or paid leave to organizations that benefit victims of the disaster. This “leave donation” is not treated as income to the employee as long as the employer donates the equivalent amount to a disaster charity. This may be an excellent option for employers whose employees weren’t directly affected but want to make a contribution to disaster victims.
The IRS makes the decision to which charities the donated dollars can go and the donations must be made within certain time limits. Also – the employees that are donating the leave cannot deduct that as their own charitable donation.
Leave Sharing Program
Similar to a leave donation program, a leave sharing program allows employees to donate part of their accrued leave into a pool, where it can then be used by employees that have exhausted their own paid time off. Under this scenario, the leave donor employee is not taxed on the donated leave, and the leave recipient employee is able to use the extra paid time off (which is taxed as wages).
A leave donation program must be established in writing with some restrictions around how the leave may be used. For example, employees may not receive cash instead of taking the actual leave days. These programs work very well in companies that have a “use it or lose it” paid leave policy. Many people with large amounts of accrued leave may be very happy to donate a portion of that to the program, particularly at year end.
Unfortunately, the California wildfires will not be the only disaster we will encounter this year. We also know from California that many insurers are excluding certain types of coverage as these disasters become more frequent. As an employer, it is important to think about how you can support your people when they need it the most. Section 139 relief can be implemented through various vehicles, including gThankYou certificates which are created to allow people to shop for food at any grocery store for whatever item they need. These relief programs are simplest to establish, as they require no written plan and no substantiation, and permit employers to provide aid such as cash, housing, certificates, medical care, and clothing immediately as long as it is reasonable to do so.
