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December 3, 2020
After the terrorist attacks on September 11, 2001, Congress added a little-known tax provision, Code Section 139, to the tax law. This provision exempts certain payments to employees from taxation during a disaster or terrorist attack.
The President’s COVID-19 national emergency declaration on March 13, 2020 triggered the disaster provisions of the tax law. The IRS specifically states that this is a “federally declared disaster” for purposes of invoking Section 139 in its COVID-19 FAQs.
Tax-Free Payments to Employees
Under this code section, a business can make tax-free payments to its employees. The qualified COVID-19 disaster relief payments are free from income tax, payroll taxes, and self-employment tax. Not only are the payments tax-free to the employee, they are deductible to you as a business expense – the best of both tax worlds. An employer can make payments for expenses incurred while the COVID-19 pandemic continues to be a qualified disaster, as determined by the President.
Expenses That May Qualify for Tax-Free Treatment
While the IRS has not provided any specific guidance on eligible COVID-19 expenses, there is IRS guidance from previous disasters, including the 2014 Ebola virus outbreak.
The following are examples of COVID-related expenses that may qualify as tax-free payments under Code Section 139:
Expenses That Do NOT Qualify for Tax-Free Treatment
What is the Catch?
As with all tax matters, there are several factors to consider before implementing this strategy. The IRS has NOT issued clear guidance directly related to the COVID-19 disaster, which leaves open some element of risk. Another key consideration is to WHOM the benefits are offered. It is unclear if the same program would need to be offered to all employees, or if you could offer different benefits to different employees, for example by job description or class. As an example, different “classes” of employees could include:
We would caution against any program that only covered owners or other highly compensated employees and is not offered to “rank and file” employees.
Documentation
The disaster provisions stipulate that employees are NOT required to account for their expenses to the employer. Therefore, no written plan or documentation is technically required if the payments received and treated as tax-free are reasonably expected to be commensurate with the expenses incurred. At a minimum, you should have employees sign a written certification that the money received is necessary for COVID-19-related expenses and that those expenses are not otherwise reimbursable.
Despite this generous relief, we recommend you implement a formal, written plan in case of IRS audit that includes:
We also recommend the following:
Example
During the COVID-19 pandemic, you established a plan to help employees with telecommuting expenses, allowing each employee to receive a $1,500 grant for equipment, supplies, and increased cost of home utilities.
Your employees John and Jane each apply and each estimate they will spend $1,500 on a form you provide. The tax results are as follows:
Conclusion
We have seen our clients go above and beyond to help their employees during this difficult time. Section 139 relief can allow the help to go even further, with no taxes owed by the employee. If you are interested in pursuing this strategy for your company, please reach out to your Beaird Harris tax advisor and we would be happy to brainstorm ideas with you.
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