For a business owner, almost nothing in life is more uncertain than running a company during a pandemic. Like most people, worry about your own livelihood, family, friends, and loved ones and how you’ll cope during COVID-19 is at the top of your mind. But unlike others, you’ve got the added concern about your employees – both for their health and safety, as well as their financial health.
While the government made some relief available in the earlier days of the pandemic such as forgivable loans like the Paycheck Protection Program (PPP) and Emergency Injury Disaster Loans (EIDL) one of the biggest benefits provided has to do with a little known tax provision to the tax law.
This provision makes it possible to provide certain payments without tax during a terrorist attack or disaster, but if it weren’t for a certain interpretation of President Trump’s declaration in March 2020, this benefit wouldn’t exist for COVID-19.
Code Section 165(i)(5)(A) and Delaying a Deadline
In March 2020, the IRS issued Notice 2020-18, which applied Section 7508A providing primarily tax deadline relief due to the pandemic.
Section 7508A gives the Treasury the authority to postpone the time for performing certain acts under the tax law for taxpayers affected by a federally declared disaster as defined by Section 165(i)(5)(A). This provision actually gives the U.S. Treasury the power to delay the deadline for up to one year.1 The delay granted was for returns and payments that would otherwise have been due originally on April 15 through July 15, 2020.
The IRS also noted its interpretation of the President’s orders as establishing a federally declared disaster within the meaning of Section 165. For affected taxpayers, this provided more than just deadline relief. What wasn’t common knowledge was that by establishing a federally declared disaster, it affected an existing and older provision.
The Law Triggered
After the terrorist attacks on September 11, 2001, Congress added a provision to the tax law allowing employers to make “qualified disaster relief payments” to employees during just such a crisis. Section 139, allows tax-free payments to assist employees in managing (in this case) the COVID-19 crisis. Distinct from gifts, the payments are tax-free to the employees, yet are a valuable tax deduction to the employer. Without this provision, the IRS treats support payments to employees as gifts, which are disallowed under Code Section 102.
What Do You Mean the Boss Can’t Give Employees a Gift?
In general, cash or property given to employees is treated as taxable income.2 Of course companies can provide support in the form of special payments or support anytime they wish, including during such a difficult time. However, the employees must report the value of the gift and pay tax on it. In most cases, if the employer makes the payments as compensation, that value is also subject to payroll taxes and/or self-employment tax. Despite the fact that a business may provide payments designated as “support,” without the Section 139 provision, the payment is taxable to the employee regardless of the employer’s purpose and intent.
Under Section 139, however, the intent of the payment does matter. The tax break applies in times of disaster, in fact, specifically, any “federally declared disaster,” which is why that IRS notice in March is so important. Section 165(i)(5)(A) defines a qualifying disaster as any event determined by the President as needing assistance by the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.
Triggered by this order, COVID-19 meets the requirements for Section 139 payments. Employers get the deduction for the qualifying payment amount, and the employee receives tax- exempt income as long as the amounts are not compensation.
What Payments Are Tax-free?
This is the tricky part. There is not a lot of guidance available, thankfully, because there have not been any national pandemics since it was enacted. As such, we have to use tax logic to tell us which types of expenses meet the definition of a “qualified disaster relief payment.”
We do, however, know which payments don’t qualify. Payments for lost wages, unemployment or sick leave or any payment in the realm of income replacement do not qualify for the tax-free treatment.3
We also know payments to businesses or payments for things insurance pays for do not qualify.4
So what is a qualified Section 139 payment? Section 139(b) defines the term, “qualified disaster relief payment” as any amount paid to or for the benefit of an individual:
(1) to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster5
(2) to reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation, or replacement, is attributable to a qualified disaster; or6
(3) by a federal, state, or local government, or agency or instrumentality thereof, in connection with a qualified disaster to promote the general welfare.7
This definition seems to include consideration of a three-part test outlined in a Supreme Court ruling in 1955, when it held that taxpayer payments in that case were “instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.8
Similar logic is included in Revenue Ruling 98-19, which concludes that relocation payments funded under the 1997 Emergency Supplemental Appropriations Act for Recovery From Natural Disasters were not includable in taxable income.9
Using this line of analysis, an employer could create payments for things like childcare costs while parents are working from home, medical costs for COVID-19 treatment, testing, or prevention, supplies such as alcohol wipes, masks, gloves, and disinfectants, home office equipment and furniture such as chairs, computers, and desks; reimbursements for internet and telephone costs; student loan payments; or other support payments due to a spouse or family member unemployment.
Recommended Documentation
In creating Section 139, Congress didn’t want those affected by the disaster to be burdened with recordkeeping or even plan documents,10 but we can infer you should be able to relate the payments to the COVID-19 pandemic because it did include the requirement that payments be commensurate with the expenses incurred. It is also wise to create a written plan document outlining the permitted payment types and process for requesting or issuing the payments.
However, the provision does not list specific requirements that employees have certain length of service or prohibit payments in favor or highly compensated employees such as programs subject to the Employee Retirement Security Income Act. Yet, it’s good to follow and apply ERISA guidelines in a plan of this nature.
Having Your Cake and Eating It, Too
Section 139 does not prohibit tax-free payments to owner/ employees of a business. As such, it is conceivable that an employer who is also an employee in the business, can receive tax-free benefits under a Section 139 plan. This provides a powerful way, provided the employer follows the above guidelines, to withdraw tax-free money from C corporations.
In addition, recognizing business deductions through S corporations, LLCs, partnerships, and sole proprietorships while the owner doesn’t have to pay tax on the payments, it effectively reduces AGI and taxable income. This can even have an impact on qualifying for any other tax benefit connected to or limited by AGI and taxable income such as increased 199A payments, improved medical deductions on Schedule A, and tax credits, to name a few.
While we have not needed it since 2002, the government created Section 139 to help people in the worst of moments. Hopefully, we won’t need it again in the near future. But in the meantime, employers should consider providing valuable relief payments to support their teams and provide a little certainty during these uncertain times.
Wondering how to implement this strategy? We’ve got you covered! Check out this plan document as a template to get started.
1 IRC Section 165(i)(5)(A)
2 IRC Section 102(c)(1)
3 Joint Committee Explanation, JCX-93-01, Dec. 21, 2001, p. 16
4 Ibid.
5 IRC Section 139(b)(1))
6IRC Section 139(b)(2))
7IRC Section 139(b)(4))
8Commissioner v. Glenshaw Glass Co., 348 U.S. 426 [47 AFTR 162] (1955), 1955-1 C.B. 207
9Rev. Rul. 98-19, 1998-1 C.B. 840
10Revenue Ruling 2003-12
