As the economic hardships of the pandemic continue to mount, many are looking for ways to help employees weather the crisis. After 9/11, the Internal Revenue Code was amended to allow employers to make direct payments to employees for qualified disaster relief under Section 139.
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Likewise, employee assistance funds are also commonly used vehicles to provide disaster relief and/or emergency hardship financial support for people affiliated with a particular employer. Both vehicles serve not only to protect one of your business’s most important assets — your people — by getting them back to work, but they also serve to boost morale, build community, and reduce employee turnover in the long run.
Both employee assistance funds and direct payments under Section 139 can help employers optimize tax efficiencies while also providing a tax-exempt benefit to employees. Yet, as with anything involving the IRS, there are more than a few rules to ensure that employees and employers alike maximize their benefits. Here’s what you need to know.
Common Employee Assistance Fund Vehicles
1. Direct payments to employees
Section 139 of the Internal Revenue Code allows employers to provide direct payments to employees for expenses arising out of a qualified disaster. This includes disasters that
- result from terrorist or military action;
- are federally declared;
- result from accidents involving common carriers;
- are an event determined by the Treasury Secretary to be catastrophic; or
- where an appropriate government authority determines an event to warrant governmental assistance.
COVID-19 has been declared a federal disaster for the entirety of the U.S., thus opening the door for employers to fully utilize Section 139 contributions to their employees for COVID-19 related expenses. However, payments may only be used to offset particular expenses, including:
- [T]o reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster,
- to reimburse or pay 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,
- by a person engaged in the furnishing or sale of transportation as a common carrier by reason of the death or personal physical injuries incurred as a result of a qualified disaster [.]
Notably, Section 139 payments can not be used to continue paying employees for work that is not being performed because of COVID-19. Additionally, Section 139 payments are permissible only to the extent they are not otherwise covered by insurance or other means.
Still, one of the advantages of using Section 139 is that employees receiving assistance do not have to provide significant documentation of their expenses.
2. Employer-sponsored charity
Large employers can establish their own dedicated charity to receive and administer funds to affected employees. These can fall into two types; public charities and private foundations. In either case, certain conditions must be met to receive the full tax-deductible benefit for both those contributing to and receiving aid from the fund, which include:
- The charity must serve a sufficiently broad charitable class of potential beneficiaries;
- The recipients must be selected based on an objective determination of need or distress and are selected by an independent selection committee (i.e. a majority of the committee consists of persons not in a position to exercise substantial influence over the employer’s affairs) or some similar procedures designed to ensure that any benefit to the employer is incidental.
If the employer-sponsored foundation does not plan to solicit outside contributions to support the employee care fund, it will be considered a private foundation. An employer-sponsored private foundation can only provide support to employees in response to a qualified disaster as described above.
Employer-sponsored private foundations are not able to provide assistance in personal hardship situations such as illness, a spouse losing his or her job, a house fire, or a similar situation.
In addition, an employer-sponsored private foundation is subject to self-dealing rules which generally prohibit most financial transactions with insiders (in tax jargon, disqualified persons). Simply stated, the foundation cannot make grants to members of the selection committee, officers, directors, or their family members without violating the self-dealing rules.
If the employer intends to solicit contributions to the fund from outside sources such as employees or the general public, it may qualify as an employer-sponsored public charity. Employer-sponsored public charities have broader latitude to provide relief than employer-sponsored private foundations; however, the funding decisions must be made by individuals who do not supervise or manage the employees.
Specifically, in addition to providing assistance in qualified disaster situations, properly structured employer-sponsored public charities may also provide assistance to employees in response to personal hardship situations such as illness, a spouse losing his or her job, a house fire or a similar situation.
3. Employer-Sponsored Donor Advised Funds
Donor-advised funds (“DAFs”) are separate funds or accounts, often maintained by community foundations or other public charities, that receive contributions from individual donors in which donors retain the right to provide recommendations regarding distributions from the fund. Employer-sponsored DAFs can make grants to employees and their family members where:
- the DAF provides relief in qualified disasters;
- the DAF serves a charitable class;
- the DAF makes an objective determination of need;
- the DAF relies on an independent selection committee;
- the employer benefit is incidental; and
- the employee’s need is documented.
Like an employer-sponsored private foundation, these funds can only be used to provide relief in qualified disaster situations, but if recipients are selected in the appropriate manner, assistance will be considered a tax-free gift to the employee.
Choosing the best fund vehicle for your company and employees
Selecting the best structure or vehicle for providing assistance to employees hinges on several factors. To determine the best option for your own business and employees, you should consider
- how long you intend to provide support (i.e., do you want to only provide relief for COVID-related exigencies or for unforeseen future qualified disasters),
- whether you want to limit support to qualified disasters or
- whether you want to expand support to individual cases of personal hardship.
Finally, employers considering employee assistance funds will need to examine the pros and cons of vehicles available for providing assistance to employees in need.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.