Can Employers Provide Tax-Free Benefits to Employees Relating to COVID-19?

During these trying times, Congress is actively looking for ways to provide relief to individuals affected by the pandemic.

Two separate pieces of legislation have been enacted, and a third stimulus bill is currently being negotiated in the Senate. But there is already a relatively obscure provision in the tax code that provides relief during times of disaster – section 139. This section allows employers to provide deductible disaster assistance to employees that is not included in the taxable income of the employees. In other words, it is a deduction/non-inclusion provision – the holy grail of tax planning.

What does section 139 cover?

According to the statute, it generally covers (i) reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster, and (ii) 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.

So what is covered and what is not?

First, some general principles: (i) it applies to all of a company’s employees, regardless of how long they have worked there, (ii) there is no cap on the amounts that can be paid to any individual employee or to all employees in the aggregate, and (iii) it does not cover items that are or will be reimbursed through insurance or some other plan or arrangement.

Here are some examples of what is covered:

• Medical and funeral expenses of the employee’s family as a result of COVID-19;
• Child care for workers whose normal source of child care is unavailable due to COVID-19; and
• Telecommuting costs such as printers, office supplies and even increased utility costs that are related to COVID-19.

And here are some examples of what is NOT covered:

• Income replacement payments such as sick pay, severance, lost wages, unemployment compensation or business income replacement; and
• Nonessential, luxury, or decorative items and services.

It will be important to document a company’s policies and procedures for claims submission and the general scope of the program, for example, but one key rule is that employees are not required to account to the employer for their expenses, provided the amounts are reasonable in relation to the type of expenses incurred.

Now that we covered the operation of the statute, does it apply in the case of COVID-19?

Most likely, yes. I say most likely because there is some ambiguity in the interaction between two different statutes. In another context, the IRS resolved the ambiguity in favor of an interpretation that suggests section 139 should apply here. There is no direct precedent in the context of section 139, but we understand the IRS is considering issuing guidance on this issue.

Here is the issue, without getting too technical. Section 139 applies if there is a “federally declared disaster” as defined in section 165. Under that section, a “federally declared disaster” means “any disaster subsequently determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.” But in the case of the COVID-19 pandemic, the President issued an “emergency declaration” under the Stafford Act, rather than a declaration of a disaster under the Stafford Act. So that is the issue – whether a “disaster” is the same thing as an “emergency.”

The IRS seems to equate the two. In Notices 2020-17 and 2020-18, both of which were issued last week, the IRS generally delayed the 4/15/2020 filing and payment deadline to July 15, 2020. In those Notices, the IRS relied on a section of the code that grants the Treasury Secretary certain authority when there is a federally declared disaster under section 165. Even though the IRS acknowledged that the President declared an emergency, it still relied on that code section to issue the Notices. This implies that an emergency is the same thing as a disaster, at least for purposes of the code section it was interpreting in the Notices. Based on this, we believe it is reasonable to conclude that there is a “federally declared disaster” for purposes of invoking section 139 in the current pandemic.

We recommend businesses consider section 139 as they deal with this crisis and decide whether and how to compensate their employees during these trying times. Employers that institute section 139 programs certainly will engender a lot of goodwill among their employees.