Tax Law Update
In the wake of the COVID-19 pandemic and shelter-in-place orders, businesses are considering ways to assist employees and other workers who are financially burdened by the crisis. One simple and tax-favorable action is to make disaster relief assistance payments under Section 139 of the Internal Revenue Code. Under Section 139, payments for personal, family, living or funeral expenses incurred as a result of the COVID-19 pandemic are both tax-free to the individual recipients and tax-deductible expenses for the payor. The payments are free of IRS reporting requirements and a plan can be quickly adopted with minimal expense.
Section 139 payments are highly tax-favorable. Section 139 payments are excluded from the recipient’s gross income and not otherwise treated as compensation or income from self-employment, and are deductible by the payor for federal income tax purposes (except to the extent self-employed individuals and other owner-employees receive a benefit as a recipient of a qualified disaster relief payment).
A broad variety of expenses may be covered by Section 139. Qualified disaster relief payments include any amount paid to or for the benefit of an individual to reimburse or pay reasonable and necessary personal, family, living or funeral expenses incurred as a result of a qualified disaster. Qualifying payments may be structured as a reimbursement of actual expenses incurred by the recipient or as payments determined by the payor to be in proportion to the recipient’s reasonable and necessary expenses incurred. There is no dollar cap on the qualifying amounts, but payments cannot be made for (1) nonessential, luxury or decorative items or services, (2) payments which are otherwise compensated for by insurance or other sources or (3) payments intended to replace lost wages or income.
Section 139 payments have low administrative and compliance requirements. Payments made pursuant to Section 139 are not required to be reported on a Form W-2 or Form 1099. Unlike various Section 132 provisions, Section 139 does not impose any discrimination rules. Businesses making Section 139 payments are not required to adopt a formal plan or policy to govern payments and are not required to obtain proof of the actual expenses incurred by the recipients as long as the payor reasonably expects the amounts to be commensurate with the amounts of the individual’s unreimbursed reasonable and necessary expenses incurred as a result of the COVID-19 pandemic. However, we recommend adopting a plan that describes the parameters and eligibility requirements for payments under the plan. Best practices also include obtaining an affirmative statement from the recipient that the funds received are necessary for expenses associated with COVID-19 and that such expenses are not reimbursable by insurance.