Disaster Relief Payments: How Businesses, Public Charities, and Private Foundations Can Provide Tax-Free Assistance to the Workforce
April 20, 2020
By: Anna E. Lantelme
As businesses face increasing uncertainty, many are simultaneously concerned for the wellbeing and financial health of their employees, independent contractors, and their families. Recently, a common request continues to emerge:
How can I provide financial assistance for my employees and now former employees that have had to be terminated at this time?
This article discusses a few options available to employers, public charities, and private foundations seeking to support such individuals, and the related tax benefits of doing so.
Disaster Relief Payments in General:
Disaster relief payments are a special exception to the rules regarding taxable income found in Internal Revenue Code (IRC) Section 139. When structured appropriately, a disaster relief payment will not be considered taxable income to the recipient, and will also qualify as a deductible expense from a company’s income.
Disaster relief payments do not require a verified need in order to provide financial assistance to employees, contractors, or their family members (for simplicity, these individuals will collectively be referred to herein as “employees”) so long as the expenses for which a payment is made is for reasonably anticipated expenses for personal, family, or living expenses during a life-altering event or qualified disaster, such as the present COVID-19 pandemic.
The following is a basic list of reasonably anticipated expenses for the present COVID-19 pandemic:
- Out-of-pocket medical expenses and health-related expenses that do not constitute medical expenses.
- Increased home expenses due to #WFH (working from home, such as internet)
- Housing costs for additional family members now residing with the employee.
- Increased childcare and tutoring expenses due to school closings.
- Additional commuting expenses (e.g. for essential employees who must now drive instead of taking public transportation).
- Increased costs of home offices supplies (additional computer monitors, highlighters, notebooks, mailing supplies, etc.)
- Food, mortgage or rent payments, car payments, and car maintenance.
- There are a few options for structuring the approach to providing disaster relief payments, each with its own rules, limitations, and tax considerations.
Employee Relief Program under IRC §139
A company is eligible to create a fund or designate payments as qualified disaster relief payments without the need of a third-party intermediary. For the most part, the company should document the reasonably anticipated needs of a particular individual and the ultimate payment provided to such employee (or former employee). The company cannot ultimate tell what the employee is allowed to use the payment for, however. Note this is quite different than the requirements placed upon an employer seeking funds from a small business loan under the CARES Act; read more about that, here.
Tax Considerations:
- From a tax perspective, payments under Section 139 are free from federal income tax, payroll taxes, and most state income taxes, unless they are otherwise required as part of an employee’s termination (such as accrued time off).
- The employer is also able to deduct such payments as business expenses as if the amounts were included as part of the employee’s wages. Therefore, there are no “caps” per se of the amount that can be deducted based upon a certain percentage of the employer’s AGI, as described below.
Employee Relief Fund Housed at a 501(c)(3) Organization
Separately, an employer could partner with a local 501(c)(3) to establish an Employee Relief Fund. The employer would make tax-deductible contributions into the fund to support those employees in financial need. Others would be able to contribute to the fund as well, including any individual, company, or charity. Further, if a private foundation made contributions to such fund, it would count as a “qualifying distribution” for its 5% annual distribution requirement.
This approach includes the popular use of donor advised funds, which can quickly be established at a sponsoring charity which has this capability established. Fidelity Charitable, Schwab Charitable, and Vanguard Charitable are three well-known organizations with this capability.
In order to comply with the charitable organization’s own governing rules, the employer cannot have a say in the ultimate selection of fund recipients, as these must be chosen by an independent committee of the 501(c)(3) based upon objective data on the recipient’s financial need. However, the employer is able to make recommendations and establish basic qualification parameters.
Tax Considerations:
- Donations to these funds are tax-deductible. For 2020, the CARES Act increased the deductibility limit for cash donations up to 100% (up from 60%) of the 2020 adjusted gross income (AGI) for individuals and up to 25% (up from 10%) for businesses. Any other form of donation would be limited to the default regime.
- Payments to recipients from the Fund are not reportable income.
A comprehensive list of Colorado disaster relief funds and charitable organizations hosting such funds can be found at Philanthropy Colorado.
Using or Establishing a Company’s Charitable Organization
Many businesses have related charitable organizations, established as a separate entity yet generally controlled by the leaders and employees of the business, aimed at employee and community disaster and emergency assistance. Such employers also offer an easy way for employees to contribute through payroll deductions and many offer matching programs for employee contributions.
To establish this type of charitable organization, the business sets up a nonprofit corporation under state law and complete of the IRS Form 1023 application. Once approved for federal tax exemption, contributions to the new nonprofit are tax-deductible as of the date the organization was formed at the state-level. This means that as soon as a company forms under state law, contributions to the nonprofit will be tax-deductible (assuming federal tax exempt status is granted).
As a related organization with a smaller pool of beneficiaries, providing for employees through a company-sponsored nonprofit organization has a few more requirements than direct payment assistance under Section 139:
- the charitable class must be open-ended, such as to benefit current employees affected by COVID-19 as well as future employees for future disasters;
- the employee must have a demonstrated, objective financial need (a short, simple application by the employee could assist, but avoid lengthy documentation for short-term relief payments);
- the recipients must be selected by a mostly independent committee, meaning that C-Suite executives and other high-level managers should not constitute the majority of the selection committee (best practice is for non-managers or unrelated mid-level managers to serve on the selection committee);
- the charity’s directors, trustees, officers, and committee members that select grant recipients are not eligible to receive financial assistance from the charity, as they are considered “disqualified persons”; and
- the fund must maintain records of payments, committee members, employee applications, and recipients.
Tax Considerations:
- Donations to the charitable organization are tax-deductible, under the same general rules as stated above. If the charitable organization is classified as a private foundation, the default regime for non-cash donations in years other than 2020 is 20% for individuals and 10% for corporations.
- Payments to recipients from the Fund are not reportable income.
The added layer of operational requirements brings with it the added bonus of tax-deductible contributions for employees, the company, and other willing donors.
Private Foundations Can Make Grants to Individuals, Too
Typically, a private foundation must receive pre-approval from the IRS for making grants to individuals. However, there is an exception for emergency assistance, hardship assistance, and medical assistance (including mental health) granted to individuals experiencing a disaster or trauma that prevents the individual from meeting their basic needs.
These rules are similar to those for an Employee Relief Fund established at a Public Charity: there is an objective determination of the recipients, the grants cannot have requirements on how they are spent, and the foundation maintains basic record-keeping to show the decision behind the individual’s selection (meaning, the individual should demonstrate the financial need).
The payments can either be made directly to the individual or to a provider of the individual (such as a mortgage company, utility company, etc.) on behalf of the selected individual.
Company Structure as a Factor
The deductibility of charitable donations in any of the above scenarios is also dependent upon the underlying structure of the business:
- C-Corporations are limited to the 10% and 25% deductibility rules. Depending upon the corporation’s AGI for 2020, it might be more beneficial to provide Disaster Relief Payments through payroll or separate checks due to the deductibility limitations.
- All other forms of businesses, including LLCs, S-corporations, and partnerships (LP, LLP, LLLP, etc.) will have any charitable contribution passed through to the individual owners, so these deductions will be governed under the individual rules for deductibility. Accordingly, any of the above approaches would be beneficial.