With the uncertainty caused by COVID-19, employers are seeking tax-efficient opportunities to financially assist employees impacted by the pandemic. On March 13, 2020, President Trump designated COVID-19 as a national emergency, affording employers additional options in providing tax-friendly benefits to its impacted employees.
Note that the options listed below are available during times when the president declares a national disaster. However, COVID-19 wasn’t explicitly designated as a national disaster in Trump’s executive order; rather, it was designated as a national emergency. Despite the designation, we expect the options below to be available to employers impacted by COVID-19.
Qualified disaster relief payments
One option is for employers to provide tax-free payments to employees impacted by COVID-19 as a “qualified disaster payment.” Under Internal Revenue Code Section 139, a qualified disaster relief payment includes any amount paid to an employee “to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster” but only to extent the expense isn’t covered by insurance or otherwise.
The amounts are excluded from gross income and aren’t treated as net earnings from self-employment, wages, or compensation subject to tax; these qualified disaster payments are fully deductible by the employer.
Qualified disaster relief payments can’t include payments of lost wages, unemployment compensation, or payments in the nature of business income replacement. Although regulations haven’t been issued on what qualifies as reasonable personal, family, and living expenses, the IRS has indicated that payments should not be intended to indemnify all losses or to reimburse the cost of nonessential, luxury, or decorative items and services. In addition, the IRS has stated that it will not require individuals to account for actual disaster-related expenses if the amount of the payments is reasonably expected to be commensurate with the expenses incurred.
The IRS provides the employer broad discretion in making tax-free payments to employees impacted by COVID-19. Such expenses could include: medical expenses, childcare or tutoring expenses due to school closings, transportation expenses, and increased home expenses due to working from home, including increased utility expenses or purchasing a home monitor and networking equipment, mortgage or rent expenses, etc.
Employers should weigh the cost of such a program against the needs of its employees in drafting or developing their policies. Factors to be considered may include, but aren’t limited to:
- Which employees are covered.
- What expenses are covered.
- Any limits to reimbursements, including amounts and types of expenses.
- Documentation of expenses requirements.
Another option that employers can implement is a leave-sharing program in which employees donate unused paid time off to help co-workers who are forced to stay home due to quarantining or to care for a family member.
Typically, tax rules require that an employee who donates leave includes the value of that leave in their own compensation at the time of the donation. However, there are important exceptions, including medical leave-sharing programs and major disaster leave-sharing programs. For the latter, a major disaster means a disaster or emergency as declared by the president. The president’s declaration most likely provides companies the opportunity to implement a leave-sharing program based on the COVID-19 pandemic, allowing employees to donate leave on a tax-free basis to a “leave bank” to be used by impacted employees (recipient employees must still include the leave as compensation when they take the leave).
A major disaster leave-sharing program is a written program with several specific requirements, including:
- The leave must be donated to an employer-sponsored leave bank to be used by employees who are adversely impacted by the major disaster requiring the employee to be absent from work.
- The plan adopts a reasonable limit of the period of time in which an employee may donate leave and when any particular employee may use leave from the bank.
- The employer must make a reasonable determination of how much leave each recipient can get based on need.
In responding to the COVID-19 national disaster, employers should evaluate all of their options to assist their employees financially during these trying times. Under the leave-sharing program or the qualified disaster relief payment programs, employers can assist employees in providing the necessary leave or financial assistance so that employees can take the time they need to address their personal lives and don’t return to work prematurely and spread the disease.
To learn more about COVID-19 leave-sharing programs, qualified disaster payment programs, or for help drafting a plan, please contact your Plante Moran advisor.