In response to the COVID-19 pandemic substantially affecting their workforces, many employers are considering programs to provide financial assistance to their employees, including those who have been furloughed or terminated. Under Section 139 of the Internal Revenue Code, employers can make grants directly to employees on a tax-free basis provided, however, they are used to pay or reimburse amounts that are reasonably expected to be incurred for incremental personal, family or living expenses as a result of COVID-19. Section 139 does not require the employer to make a specific assessment of the financial need of the employee.
As an alternative or in addition to establishing a program under the Section 139 relief regime, an employer can establish an Employee Relief Fund as a Section 501(c)(3) tax-exempt organization funded with tax-deductible charitable contributions made by the employer and others interested in supporting those employees in financial need as a result of the COVID-19 pandemic. These funds can make a broader array of tax-free distributions to employees although, unlike a Section 139 program, payments from an Employee Relief Fund must comply with a wide array of IRS requirements, including the selection of the recipients by an independent selection committee based on an objective determination of financial need.
Tax-Exempt Organizations Housing the Employee Relief Fund
Employee Relief Funds may be housed at a variety of tax-exempt organizations. While an employer may establish a new charitable organization and apply for tax-exempt status with the IRS, precious time and resources may be saved by using existing charities to operate the fund. This may include using an existing employer-sponsored public charity and an employer-sponsored private foundation that has certain required safeguards in place. An alternative to an employer-sponsored charity is for an employer to partner with a third-party charity, such as a local community foundation or other public charity that offers Employee Relief Funds.
Tax Benefits of Employee Relief Fund
- Contributions to an Employee Relief Fund are eligible for a charitable deduction for federal income tax purposes and, if made by a private foundation, constitute “qualifying distributions” for purposes of the five percent minimum annual distribution requirement.
- Relief payments to employees are not taxable compensation and are free from reporting on Form W-2.
Nature of Allowable Relief Payments
Payments from an Employee Relief Fund would include those described as “qualified disaster relief payments” under Section 139, which include payments for the following expenses incurred by an employee as a result of the COVID-19 pandemic:
- Unreimbursed medical expenses and health-related expenses that do not constitute medical expenses.
- Home expenses due to telecommuting.
- Housing costs for additional family members.
- Increased childcare and tutoring costs due to school closings.
- Additional commuting expenses.
- Increased costs of home offices supplies.
The IRS has indicated that the following type of assistance would also be permissible:
- Assistance with rent, mortgage payments or car loans to prevent loss of a primary home or transportation that would cause additional trauma to families already suffering.
- Assistance with elementary and secondary school tuition and higher education costs to permit a child to attend school.
- Assistance to provide food or shelter.
Other IRS Requirements
- The proposed relief program must be open-ended and include employees affected by the COVID-19 crisis and those who may be affected by a future disaster.
- The selection of employees for relief must be based on an objective determination of financial need.
- An Independent Selection Committee must make the determination regarding the selection of employees to receive relief.
- An Employee Relief Fund must maintain adequate records to show that its payments further its charitable purposes and that the employees receiving payments are needy or distressed.
Buchanan’s tax attorneys remain available to assist with establishing charitable funds and all related IRS tax matters for employers.