With the COVID-19 crisis pushing people across the country into financial hardship, it’s natural that some nonprofits want to extend a helping hand to staff members. The good news is that the federal tax code provides a way to make tax-free direct payments to your employees who’re in need.
Section 139 of the Internal Revenue Code permits employers to provide direct payments to employees to cover expenses arising out of a “qualified disaster.” There are many types of qualified disasters, but they typically arise in the context of local or regional adversity such as hurricanes. The pandemic has been federally declared a disaster for the entire country.
These disbursements to employees generally are excluded from the recipients’ gross income for federal tax purposes, and you don’t need to report them on W-2 forms. Excludable payments include payments or reimbursements for reasonable and necessary:
Personal, family, living or funeral expenses, and
Repair, rehabilitation or replacement of an individual’s personal residence or its contents.
Examples of pandemic-related expenses that may be eligible for reimbursement include tutoring expenses for employees’ children attending school virtually due to school closures, and additional costs incurred while working from home when workplaces are closed. Qualified disaster payments don’t include payments for expenses otherwise covered by insurance or other reimbursements. But any COVID-19 medical expenses not so covered can be reimbursed to employees.
Payments for income replacement, such as lost wages, lost business income or unemployment compensation, aren’t considered qualified disaster payments. In other words, you can’t make tax-free payments to employees for work that, because of COVID-19, they aren’t performing.
Legal and practical considerations
Before moving ahead with giving out payments, think about potential legal implications. For example, although Sec. 139 itself doesn’t include any nondiscrimination rules, payments made under the provision could be subject to discrimination prohibitions in other state and federal laws. In addition, your state might not exclude the payments from income.
You also shouldn’t make the payments on an informal basis. Develop guidelines addressing matters such as eligibility, the documentation you’ll require to receive a payment, the payment amount, and the records you’ll maintain. Note that individuals aren’t required to account for their actual expenses to qualify for the income exclusion as long as the amount of payments is commensurate with expenses incurred.
Do it right
The IRS has issued sparse formal guidance on how to properly implement these payments, but don’t let that deter you. Your CPA can help you develop procedures to provide much needed — and likely much appreciated — support.
How HoganTaylor Can Help
The HoganTaylor Nonprofit team of business advisors and CPAs is comprised of former CFOs, controllers, and industry experts with extensive experience providing the guidance organizations need to lean forward again in their leadership. If you have any questions about this content, or if you would like more information about HoganTaylor’s Nonprofit practice, please contact the Jack Murray, CPA, Nonprofit Practice Lead, at firstname.lastname@example.org.
INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.