How employers can assist employees impacted by major disasters
Tax-advantaged methods for helping disaster victims
INSIGHT ARTICLE |
In the wake of Hurricanes Harvey and Irma, many employers are seeking ways to financially assist employees who were impacted by these disasters. Co-workers of the disaster victims may also want to provide funds for the relief effort. Several tax-advantaged arrangements, discussed below, allow employers and employees to financially assist affected employees.
Qualified disaster relief payments
Employers can make direct payments to affected employees which are not taxable if the requirements for qualified disaster relief payments under section 139 are met. If qualified, the payments are not treated as wages and are excludable from federal income tax, employment taxes and Form W-2 reporting.
The payments must be made due to a qualified disaster, such as a federally declared disaster or a disaster resulting from terroristic or military actions or other catastrophic events. Qualified disaster relief payments include amounts paid to or for the benefit of an individual to reimburse or pay personal, family, living or funeral expenses incurred as a result of the disaster. Expenses for medical care, temporary housing and transportation can also be covered. In addition, expenses incurred for the repair or rehabilitation of an individual’s residence, or for repair or replacement of its contents, may qualify.
In order for an employer’s direct payment to be excludable from an employee’s income, the employee’s expenses must be reasonable and necessary and cannot be compensated for by insurance or otherwise. Employees are not be required to account for actual expenses in order to qualify for the exclusion, provided that the amount of the payments they receive can be reasonably expected to be commensurate with the expenses incurred. Employees are not entitled to any other tax deduction or credit on their individual income tax returns due to expenses for which they receive qualified disaster relief payments. Qualified disaster relief payments are deductible by employers as business expenses.
Other employer-sponsored programs
Other ways that employers can assist employees facing financial loss due to a disaster is through employer-sponsored donor advised funds, private foundations or public charities.
There are different requirements that apply to each type of program so an employer would need to determine which program best suits its needs, and then work with appropriate advisers to establish the program. If the requirements are met, the payments to the affected employees are not taxable compensation to them.
- Employer-sponsored donor advised funds are created when an employer contributes to a separate account held by a community foundation or public charity to benefit the employer’s employees and their family members impacted by a disaster. The funds can only be used for a qualified disaster and not for other purposes. The account holder is required to maintain adequate records to demonstrate the recipients’ need for the disaster assistance provided.
- Employer-sponsored private foundations may provide assistance to employees or family members affected by a disaster, as long as certain safeguards are in place to ensure that this assistance is serving charitable purposes rather than the business purposes of the employer. These private foundations can only make payments due to qualified disasters and not for non-qualified disasters or other emergency hardship situations.
- Employer-sponsored public charities can assist employees with any type of disaster or emergency hardship situation, as long as the sponsoring employer does not exercise excessive control over the organization. Consequently, an employer-sponsored public charity can provide a broader range of assistance to employees than can be provided by employer-sponsored donor advised funds or private foundations.
Under each of these programs, the recipients must be in a charitable class and be selected based on an objective determination of need. The recipients must be chosen either by an independent selection committee or through other procedures which ensure that any benefit to the employer is incidental and tenuous. Additional information about these programs is available in IRS Publication 3833, Disaster Relief: Providing Assistance through Charitable Organizations.
Employer-sponsored leave-donation programs allow employees to trade their paid leave for cash payments made by their employers to charities. When employees forgo vacation, sick or personal leave, the leave is not treated as wages if exchanged for employer payments to qualified charities by certain dates set by the IRS. Since the donated leave is not taxable income, it is not included in Boxes 1, 3 or 5 of the donor’s Form W-2.
With regard to Hurricane Harvey and Tropical Storm Harvey, IRS Notice 2017-48 states that the donated leave will not be taxable income to the leave donor if paid to a qualified charity for disaster relief before January 1, 2019. The IRS granted the same relief with regard to Hurricane and Tropical Storm Irma in Notice 2017-52. Therefore, disaster relief contributions due to either Harvy or Irma must be made to a qualified charity by January 1, 2019, to avoid taxation on the leave donor.
Employees cannot claim a charitable contribution on their individual income tax returns for the donated leave. Employers making the charitable contributions can deduct these contributions as a trade or business expense without regard to the normal restrictions on charitable contributions.
Employers can also sponsor leave-sharing plans which allow employees to donate leave to their fellow employees impacted by a major disaster as additional paid time-off. Plans which meet the IRS requirements treat the donated leave as wages of the recipient, not of the donor, and thus allow the leave donor to avoid federal taxation on the donated leave. Donated leave received by a recipient is treated as wages subject to federal income tax and employment tax withholding. Leave donors are not entitled to a charitable contribution on their individual income tax returns for the donated leave.
The requirements for major disaster leave-sharing plans are detailed in Notice 2006-59 and summarized here:
- The plan must be in writing and apply only to an event declared by the President of the United States as a major disaster or emergency.
- The employee donating leave can deposit accrued leave (up to the maximum amount the employee normally accrues during the year) into an employer-sponsored leave bank for use by other employees who have been adversely affected by the disaster; however, the donor cannot designate a specific recipient.
- An employee can receive the leave if the disaster has caused severe hardship to the employee or a family member that requires the employee to be absent from work. The leave recipient is paid leave (at his or her normal rate of compensation) from the leave bank for purposes related to the disaster, and cannot convert the leave into cash in lieu of using the leave.
- The plan applies a reasonable limit on the period of time during which leave can be donated and used, and also imposes a limit on how much leave any one recipient may receive. Leave donated on account of one major disaster may only be used for employees affected by that disaster, and unused leave in the bank must be returned to the leave donors.
Other employee contributions
Employees may choose to contribute funds to qualified charities for disaster relief through programs sponsored by their employers. Employees can send their contributions directly to the charities or have them collected by the employer, such as via after-tax payroll deduction, and then forwarded to the charities. Employees may be entitled to a charitable contribution deduction on their individual income tax returns for these contributions.
Employees who make after-tax contributions to a non-exempt fund held by their employer to provide qualified disaster relief payments directly to affected co-workers would not be entitled to a charitable contribution on their individual income tax returns since the contributions are not made to qualified charities.
Employers expecting to provide financial assistance to employees who are disaster victims should consider the various tax-advantaged programs available. Since the requirements of each program vary, it is important that employers properly structure their programs in order to obtain the tax benefits for the donors of the assistance and the recipients.