Apr 9, 2020
Employer Sponsored Disaster Relief Programs – Four Options to Consider
By Ofer Lion and Christian Canas
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With the COVID-19 pandemic now a presidentially-declared national emergency—and for this purpose a “qualified disaster”—employers nationwide have several options available for providing employees and their families in need with tax-free financial assistance that is also deductible to the employer (some at enhanced deduction limits for 2020 contributions1). The following four options and their pros and cons are detailed here, including direct disaster relief payments to employees and indirect payments through controlled or third party charitable organizations:
- Section 139 Disaster Relief Payments from Employers to Employees
- Employer-Sponsored Disaster Relief Funds (hosted by a community foundation or other third-party 501(c)(3) public charity sponsor)
- Employer-Sponsored / Controlled 501(c)(3) Private Foundations (funded primarily by the employer)
- Employer-Sponsored / Controlled 501(c)(3) Public Charities (funded by a broad base of donors, often the employees with matching amounts from the employer)
1. Section 139 Disaster Relief Payments from Employer to Employees
- Financial assistance paid directly by the employer to reimburse or pay “reasonable and necessary” personal, family, living or funeral expenses arising from a “qualified disaster” and “only to the extent any expense compensated by such payment is not otherwise paid by insurance or otherwise” (see the below note on “reasonable and necessary” expenses). There is no specific cap on the amount of qualifying assistance that may be provided to an employee pursuant to section 139 of the Internal Revenue Code.
- Qualified disaster relief payments do not include income replacement payments, such as payments of lost wages or unemployment compensation.
- A review of some objective criteria supplied by the employee/applicant is required. Once the employer has established appropriate procedures for requesting and approving payments (see the below note about preparing and adopting a formal disaster relief program document), the employer can proceed immediately.
- Employer Contributions Deductible: Payments are deductible to the employer as ordinary and necessary business expenses.
- Individual Contributions Not Deductible: However, contributions from directors and officers of the employer (or other individuals) to help fund these financial assistance payments are not eligible for charitable contribution deductions.
- Tax-Free to Recipients: Payments received are excluded from the employee’s gross income for federal income and employment tax purposes (i.e., not subject to federal income tax, Social Security, Medicare, and unemployment taxes). However, payments may be subject to state taxes and/or withholding requirements. For example, California law generally provides that section 139 disaster relief payments made by an employer are not subject to state withholding or reportable as wages, but are subject to state UI, ETT and SDI.2
2. Employer-Sponsored Disaster Relief Fund (hosted by a community foundation or other third-party 501(c)(3) public charity sponsor)
- The fund is held by an existing, third-party 501(c)(3) public charity and administered by that sponsor or a related service provider. The public charity sponsor establishes a dedicated fund, receives contributions, issues gift receipts, and supplies communications materials, typically through an online application and electronic payment platform. The public charity sponsor may assist with creating the program materials (including who is eligible, maximum grant amounts, etc.). These funds can be established quickly and, with an established online platform, can be ramped up as fast or faster than employer provided section 139 disaster payments (option 1 above).
- The fund serves to provide relief from one or more “qualified disasters” and recipients are selected by an independent selection committee based on an objective determination of need. The selection committee is considered independent if a majority of its members consists of persons who are not in a position to exercise substantial influence over the employer’s affairs.
- The relationship between the employer and the public charity sponsor is governed by a fund agreement by and between the two parties. The public charity sponsor generally charges a fee based on a percentage of contributions to the fund and/or the number of outgoing grants, often with a minimum fee amount. However, financial assistance may be provided through the fund without the time and expense of forming and operating a new 501(c)(3) organization (see options 3 and 4, below). The sponsor handles recordkeeping requirements and reports contributions received and grants paid on its annual tax returns.
- Employer Contributions Deductible (Enhanced for 2020): Employer contributions to the fund are eligible for a charitable contribution deduction (at enhanced levels this year for cash contributions only—up to 25% of a corporation’s taxable income).
- Individual Contributions Deductible (Enhanced for 2020): Contributions from directors and officers of the employer (and other individuals) to the fund are eligible for charitable contribution deductions (at enhanced levels this year for cash contributions—uncapped such that individual donors can effectively zero-out their adjusted gross income, and even carry forward deductions in excess of that amount into later years).
- Tax-Free to Recipients: Grants received are excluded from the employee’s gross income.
3. Employer-Sponsored / Controlled 501(c)(3) Private Foundations (funded primarily by the employer)
- Formation of a new nonprofit corporation can take some time, and waiting for a tax-exemption determination letter even longer, albeit that an expedite request likely would be granted. That said, given the “stay-at-home” orders currently in effect, many IRS agents included, even an expedited application for recognition of tax-exempt status may take several weeks to be approved by the IRS. The new foundation may begin operations in advance of receiving the determination letter, although non-employer donors may be hesitant to make contributions without a determination letter in hand.
- The new foundation would need a board of directors, officers, a bank account, etc. and would be subject to federal and state annual filings, including the IRS Form 990-PF (the tax return filed by private foundations). The employer typically contributes office space and administrative services to the foundation at no charge to assist with its operation. The foundation would receive contributions, issue gift receipts, develop and implement the grant application and selection process, and make grants to qualifying recipients.
- The private foundation will only be able to make payments to employees or their family members affected by “qualified disasters” (including a federally declared disaster or emergency under the Stafford Act, the COVID-19 national emergency included). This restriction may limit the foundation’s future utility once the current crisis has abated.
- Akin to option 2, recipients must be selected by an independent selection committee based on objective determinations of need.
- Employer Contributions are Deductible: Employer contributions to the private foundation are eligible for a charitable contribution deduction (up to the standard 10% of a corporation’s taxable income).
- Individual Contributions are Deductible: Contributions from directors and officers of the employer to the private foundation are eligible for charitable contribution deductions (at standard deduction limits for contributions to private foundations, which generally are lower than the limits for contributions to public charities).
- Tax-Free to Recipients: Grants received are excluded from the employee’s gross income.
4. Employer-Sponsored / Controlled 501(c)(3) Public Charity (funded by a broad base of donors, often the employees with matching amounts from the employer)
This structure is similar to the private foundation in option 3, with the following key enhancements:
- A public charity can make payments to employees or their family members affected by qualified disasters and in non-qualified disasters or in emergency hardship situations (e.g., victims of crime or an uninsured personal loss such as a fire, or a sudden death in the family), which may provide better future utility once the current crisis has abated.
- Enhanced Deduction for Employer Contributions (2020): Employer contributions to the public charity are eligible for a charitable contribution deduction (at enhanced levels this year for cash contributions—up to 25% of a corporation’s taxable income).
- Enhanced Deduction for Individual Contributions (2020): Contributions from directors and officers of the employer (and other individuals) to the public charity are eligible for charitable contribution deductions (also at enhanced levels this year for cash contributions—uncapped such that donors can effectively zero-out their adjusted gross income, and even carry forward deductions in excess of that amount into later years).
A couple of notes on qualified disaster relief payments generally:
- “Reasonable and necessary” expenses could include reimbursements for unreimbursed childcare costs incurred due to school closures, medical expenses, costs incurred by an employee to rent or buy additional space or equipment to work from home due to stay at home orders or facility closures, etc.
- Employers should establish a plan document outlining appropriate procedures for requesting and approving payments, including certifications to ask of the employee applicant. IRS Publication 3833 (Disaster Relief, Providing Assistance Through Charitable Organizations)3 and Revenue Ruling 2003-124 have some pertinent guidance in this regard.
Employers have several options for providing tax-free aid to employees in financial distress, including through direct disaster relief payments and indirect payments through controlled or third party charitable organizations. Employers should carefully consider the pros and cons of these options in evaluating how to quickly and effectively assist their employees during these difficult times. If properly structured and administered, all of the above options can provide significant tax benefits to both employers and employees.
1 Options 2 and 4 offer enhanced charitable contribution deduction rates to contributing employers and other individuals. For additional information regarding the enhanced charitable contribution rules enacted under the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), please see https://www.seyfarth.com/news-insights/super-deductible-contributions-and-other-charitable-giving-items-in-the-cares-act.html.