For those caught in the path of Hurricane Sandy, the past few days represent a life-changing event. Many employers are eager to find a way to assist employees as they address the damage and destruction. Tax provisions passed in the wake of the September 11, 2001 attacks provide employers a simple, direct option: qualified disaster relief payments.
Section 139 of the Internal Revenue Code, added by the Victims of Terrorism Tax Relief Act of 2001, establishes a federal income exclusion for payments received in the wake of a “qualified disaster.” This means that an employer can give the employee cash to help them through a disaster, and the employee does not have to pay income tax on that cash. These payments are generally deductible business expenses for employers. No federal payroll taxes apply to the disaster relief payments for either the employer or employee.
“Qualified disasters” include presidentially declared disasters like Hurricane Sandy (with declarations issued for Connecticut, New Jersey, and New York on October 30, 2012), terrorist or military events, common carrier accidents (e.g., passenger train collisions), and other events that the U.S. Secretary of the Treasury concludes are catastrophic.
Employers that want to provide disaster relief assistance to their employees and their families through direct payments should take steps to make certain the payments provided are tax-favored qualified disaster relief payments by taking the following steps:
- Identify what expenses the payments would reimburse. Code Section 139 allows payments for “personal, family, living, or funeral expenses,” as well as the costs of home repair and the replacement of personal items due to a qualified disaster.
- Confirm that the employees who will receive the disaster relief payments are within the declared disaster area or are otherwise eligible for payments under Code Section 139.
- Do not make payments for expenses covered by insurance or other sources. Any amount reimbursed by another source is not eligible to be a qualified disaster relief payment. Also do not make payments for lost income or compensation, since those payments do not qualify as disaster relief payments.
- Have a written policy describing how payments are intended to approximate the losses actually incurred by employees. Given the circumstances, the IRS has stated it will not require employees to substantiate their expenses in order to exclude these disaster relief payments from their taxable income.
- Review terms of 401(k) and retirement plans to make sure that you properly include the non-taxable payments as compensation under those plans if your plan document would require you to do so.
- Consider any state tax law implications.
Qualified disaster relief payments offer employers a direct, immediate method for assisting employees affected by Hurricane Sandy and other disasters. Employers who decide to make these payments will want to comply with Code Section 139 to maximize the benefit to their employees and obtain the tax advantages available without the administrative hurdles involved in other charitable initiatives, such as establishing and funding charitable organizations or private foundations.