FAQs: Section 139

Alerts / April 10, 2020
Q: In addition to the CARES Act and other provisions of employee benefit plans described below, what other forms of hardship assistance are employers considering in order to support their employees who are facing health and financial hardship as a result of the COVID‑19 outbreak?

A: Various strategies including the creation of a “disaster relief fund,” are being designed to qualify under Internal Revenue Code Section 139. On March 13, 2020, the president issued an emergency declaration under the Robert T. Stafford Relief and Emergency Act with respect to the COVID-19 pandemic. The IRS interpreted the president’s declaration as constituting a “federally declared disaster” within the meanings of Section 139(c)(2) and 165(i)(5)(A) thereby triggering the applicability of Section 139. While cash payments to workers are generally regarded as taxable income, once a “federally declared disaster” has been declared, Section 139 allows employers to make “qualified disaster relief payments” to their employees that are not taxable income to the recipient.

Q: What payments to employees qualify as qualified disaster relief payments?

A: Section 139 specifically allows employers “to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses as incurred as a result of a qualified disaster.” There is a lack of IRS precedent on exactly what qualifies in the context of a global pandemic like COVID‑19, but basic necessities such as food, shelter, child care, telecommuting and unreimbursed medical expenses should qualify. The IRS has indicated that recipients will not be required to account for actual disaster relief payments in order to qualify for the Section 139 exclusion, provided that the amount of the payment can be reasonably expected to be commensurate with the expense incurred.

Q: What payments made by employers to employees would not be covered by Section 139?

A: Section 139 qualified payments do not include any amounts designed as wage replacement, amounts reimbursed by insurance, and amounts that were not incurred with respect to the declared disaster.

Q: Are employers entitled to a tax deduction for disaster relief payments in the same manner as payment of regular wages?

A: Yes.

Q: Is the tax-free treatment of qualified disaster relief payments limited to those made by employers?

A: No. If the payments qualify under Section 139, they will retain their tax‑free status regardless of their source. For example, they can be received from a Section 501(c)(3) tax‑exempt charitable organization if certain tax requirements are met. See the discussion below.

Q: What other requirements must an employer meet under Section 139?

A: If an employer desires to utilize an employer-sponsored charitable organization (such as an embedded foundation) to create and administer a disaster relief fund, that fund cannot be established solely for the provision of relief for a specific event or disaster like COVID‑19 but must be designed to benefit a charitable class that is sufficiently large or indefinite. In addition, recipients must be selected based on an objective determination of need and must be selected by an independent selection committee, or an adequate substitute must be in place to ensure that any benefit to the sponsoring employer is incidental and tenuous. The committee overseeing the disaster relief also should be composed exclusively of or at least by a majority of independent directors who are not in a position to exercise substantial influence over the affairs of the employer.

Q: Is Section 139 available for state income tax purposes as well?

A Yes, as long as that state is among the states that “piggy‑back” the Internal Revenue Code as their internal income tax law (most states that impose a state income tax have some form of such conformity).

Q: What else are employers doing or have they done previously to assist their employees?

A: Another assistance model is an employee assistance fund (“EAF”). The EAF is designed to provide assistance in connection with both a disaster and an employee experiencing personal financial hardship. EAF payments are not designed to replace wages, but these payments do not qualify as disaster relief payments under Section 139. Effectively, EAF payments would assist the employee in paying for specific bills, but are not equivalent to the amount of lost wages. The other requirements the employer must meet for the disaster relief fund discussed above are essentially the same for an EAF.

Q: What about employers that fund relief fund programs through charitable organizations (public charities) that were formed to assist employees in connection with a disaster or a personal financial hardship?

A: In the past, employer‑sponsored charitable organizations were considered to result in “private benefit” to a sponsoring employer because they were often formed to enhance employer interests and the employer held undue influence over the selection of recipients of hardship payments. The types of benefits that a charitable organization is permitted to provide through an employer‑sponsored assistance program depend in part on whether the organization is classified as a public charity, a donor-advised fund or a private foundation.

Q: How does the employer‑sponsored public charity work?

A: These charities can provide disaster assistance in any type of disaster or hardship situation, as long as various IRS requirements are met. As discussed above, these requirements include ensuring the class of beneficiaries is sufficiently large or indefinite by including both current and future employees, and covering not only the COVID‑19 disaster but also potential future disasters. Recipients also must be selected based on an objective determination of need, and selections must be made by an independent selection committee or by adequate substitute measures to ensure that any benefit to the sponsoring employer is incidental and tenuous. Ideally, this committee would be composed exclusively of or have at least a majority of independent directors who are not in a position to exercise substantial influence over the affairs of the employer.

If applicable conditions are met, the public charity’s payments to employees and family members in response to a disaster or emergency hardship are presumed to be made for charitable purposes and therefore do not result in taxable compensation to the employees. These payments may or may not qualify as qualified disaster relief payments under Section 139 as discussed above.

Q; What about the requirements of donor-advised funds and private foundations?

A: There are additional assistance models and requirements that can be explored. Each has more complicated IRS requirements.

Authorship Credit: Emily C. Crosby and Mark S. Lange

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