Certain Disaster Relief Payments Tax-Free to Employees

April 1, 2020 | Article

On March 13, 2020, President Trump issued an emergency declaration under the Stafford Act in response to the ongoing Coronavirus Disease 2019 (COVID-19) pandemic. While there are varying interpretations, this declaration appears to meet the requirements of a declared disaster.

Amounts paid to or for the benefit of an employee may be excluded from employee income under Code section 139 (but still fully deducted by the employer) if related to a qualified disaster. A qualified disaster in this context is defined as resulting from a terrorist or military action, catastrophic accidents, or federally declared disaster whereby the president warrants governmental assistance under the Stafford Act.

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Consequently, employer reimbursement payments to employees for reasonable and necessary expenses related to the COVID-19 emergency that are unreimbursed by insurance, or some other form of reimbursement, should be excludable from the employees’ income, and deductible by the employer.

Types of Expenses that Qualify
The types of qualified disaster related expenses generally eligible for reimbursement to employees include:

  • Personal, family, living, or funeral expenses–including personal property expenses
  • Repair or rehabilitation of a personal residence or repair or replace its contents
  • Amounts paid by a governmental agency in connection with a qualified disaster in order to promote the general welfare

As a result of the COVID-19 emergency, employer reimbursement payments may relate to additional employee expenses due to medical treatments and medications not covered by insurance, incremental costs of working from home, extra child-care and other factors.

Payments of this nature will not be treated as net earnings from self-employment or wages for the recipient and are not subject to withholding, payroll, or self-employment taxes. It would be reasonable to assume the payments do not need to be included in a recipient’s W-2 or form 1099. While many states follow federal law, some states do not. Accordingly, the tax treatment of qualified disaster relief payments to employees may vary state to state.

Types of Expenses that do not Qualify
The exclusion does not intend to cover income replacement payments, for lost wages or unemployment compensation, for example. So, it appears mandatory paid sick or family and medical leave would not fall under the exclusion from gross income and would constitute taxable wages.

Since the employer reimbursements are intended to provide relief or mitigation for employees’ expenses or losses as a result of a disaster, such as the COVID-19 emergency, employees forgo any deduction for those costs.

Recipients of qualified disaster related payments aren’t required to account for actual expenses to qualify for the exclusion from gross income if the payments are reasonably in line with expected actual costs.

The Importance of Documentation
There does not appear to be a limitation on the amount an employer can provide for these expenses and no formal plan by the employer is required. However, it would be advisable for the employer to create an administrative process or program for:

  • Documenting employees’ requests for reimbursement of specific expenses
  • Establishing maximum reimbursement thresholds
  • Detailing other administrative requirements to allow the employee to obtain reimbursements over the duration of the declared disaster or emergency.

As organizations grapple with the impact of COVID-19, it’s important to document actions taken related to payments to employees, even if they are covered under a disaster declaration, like the Stafford Act.

There’s much to consider when it comes to COVID-19’s impact on you and your business.

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