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Daily Tax Report: State

INSIGHT: Using Employee Relief Funds to Provide Tax-Free Assistance

April 2, 2020, 1:00 PM

In response to the Covid-19 crisis substantially impacting their workforces, many employers are considering establishing programs to provide financial assistance to their affected employees, including those who have been furloughed, had their work hours reduced, or been terminated. Under tax code Section 139, employers can provide assistance directly to an employee free of income tax, provided, however, they are used to pay or reimburse amounts that are reasonably expected to be incurred for incremental personal, family, or living expenses as a result of the Covid-19 crisis. There is no requirement under Section 139 for the employer to make a specific assessment of the financial need of the employee.

As an alternative or in addition to establishing a program under the Section 139 relief regime, an employer can establish an employee relief fund as a charitable fund maintained at a Section 501(c)(3) tax-exempt organization that is funded with tax-deductible charitable contributions made by the employer and others interested in supporting those employees in financial need as a result of the Covid-19 pandemic. The scope of the allowable tax-free distributions made by these funds is much broader than those payments allowable under Section 139 although, unlike in the context of a Section 139 program, payments from an employee relief fund must comply with various IRS requirements applicable to charitable funds, including the selection of the recipients by an independent selection committee based on an objective determination of financial need.

Housing the Employee Relief Fund with a Tax-Exempt Organization

Employee relief funds may be housed at a variety of tax-exempt organizations. While an employer may establish a new charitable organization and apply for tax-exempt status with the IRS, precious time and resources may be saved by using existing charities to operate the fund. This may include using an existing employer-sponsored public charity and, because the Covid-19 crisis constitutes a “qualified disaster” under Section 139, an employer-sponsored private foundation that has certain required safeguards in place.

As an alternative to using an employer-sponsored charity, an employer can partner with a multitude of third-party charitable organizations, such as a local community foundation or other public charity that offers employee relief funds. These organizations already have an established infrastructure in place and can quickly launch and mobilize these funds in a manner that aligns with the employer’s values and culture.

Charitable Income Tax Deduction for Contributions to Employee Relief Fund

Contributions to an employee relief fund are eligible for a charitable deduction for federal income tax purposes. There are generally no limitations on who may contribute to a fund and receive this tax benefit. For example, the employer, its employees, or the public at large can all contribute on a tax-deductible basis. Private foundations may also contribute to these funds, with such contributions qualifying as “qualifying distributions” that may be applied against the 5% minimum annual distribution requirement imposed on private foundations.

Tax-Free Treatment of Distributions to Employees from Employee Relief Fund

Provided an employee relief fund meets the applicable IRS requirements, including (as discussed further below) having a significantly large “charitable class,” the selection of the recipients on an objective determination of need, and an independent selection committee selecting the recipients, payments to employees from the fund will not constitute taxable income, and will be free from any Form W-2 reporting requirements. Although the payments from an employee relief fund are not excluded from taxable income under Section 139, they are considered to constitute gifts made out of “detached and disinterested generosity” that are excluded from gross income under Section 102. Distributions cannot be made solely on the basis of the Covid-19 crisis, but must be based upon a specific assessment that the recipient is financially or otherwise in need. Individuals do not have to be totally destitute to be financially needy, but may merely lack the resources to obtain basic necessities.

Payments from an employee relief fund would include those described as “qualified disaster relief payments” under Section 139, which may include payments for the following expenses incurred by an employee as a result of the Covid-19 pandemic:

  • Unreimbursed medical expenses and health-related expenses

  • Home expenses due to telecommuting

  • Housing costs for additional family members

  • Increased childcare and tutoring costs due to school closings

  • Additional commuting expenses

  • Increased costs of home offices supplies

In addition to the foregoing incremental expenses incurred as a result of a disaster, an employee relief funds may also provide assistance in the form of funds, services, or goods to ensure that employees have the basic necessities, such as food, clothing, housing, transportation, and medical assistance. The type of aid that is appropriate depends upon an individual’s needs and resources. The Internal Revenue Service has indicated that disaster relief organizations are generally in the best position to determine the type of assistance that is appropriate. For example, immediately following a devastating flood, a family may be in need of food, clothing, and shelter, regardless of their financial resources. However, they may not require long-term assistance if they have adequate financial resources. Individuals who are financially needy or otherwise distressed are appropriate recipients of long-term assistance.

The IRS has indicated that the following type of assistance provided on account of a particular disaster, if based on individual need, would be permissible:

  • Assistance with rent, mortgage payments, or car loans to prevent loss of a primary home or transportation that would cause additional trauma to families already suffering.

  • Assistance with elementary and secondary school tuition and higher education costs to permit a child to attend school.

  • Assistance to provide food or shelter.

Payments for these expenses, even though not constituting “qualified disaster relief payments” under the purview of Section 139, are nonetheless allowable, again provided that the employee relief fund meets the applicable IRS requirements.

Group of Individuals Eligible to Receive Relief Must Be Considered to Constitute a ‘Charitable Class’

The IRS requires the pool of eligible recipients of an employee relief fund to be broad enough to be considered indeterminable and, therefore, considered to be a “charitable class.” Otherwise, the class will be considered too small, and the fund will be deemed to be serving private rather than public interests. If the group of eligible recipients is limited to a smaller group, such as the employees of a particular employer, the group of persons eligible for assistance must be indefinite. In this context, to be considered to benefit an indefinite class, the proposed relief program must be open-ended and include employees affected by a current disaster and those who may be affected by a future disaster. Accordingly, if a charity follows a policy of assisting employees who are victims of all disasters, present or future, it would be providing assistance to an indefinite charitable class.

Recipients of Relief Must be Selected Based on Need

The employee relief fund must select recipients based on an objective determination of the recipient’s financial need. It is vital that the employee relief fund establish a specific, written list of criteria for the selection of recipients before it begins administering aid. A best practice would be for the fund to require an application from the employee describing need and available resources to meet the need. The IRS has recognized that the standards for immediate emergency relief can be more lax than longer-term assistance. For example, it would be inappropriate to require exhaustive documentation from an applicant who provides reasonable evidence that they are homeless due to an eviction or hospitalized due to Covid-19.

The personal circumstances of each potential recipient must be considered in the selection process. Merely being negatively affected by Covid-19 in some way is not enough. For example, a laid off worker who is independently wealthy may qualify for emergency relief in the short-term, but is likely not an appropriate recipient of long-term financial assistance. It would also be unreasonable to require recipients to be completely destitute before they can qualify for relief.

Selection of Recipients by Independent Selection Committee

Because an employee relief fund is typically associated with a business (i.e., the employer), the IRS requires the fund to be sufficiently independent from the business. It is acceptable for individuals associated with the business to serve on the selection committee, but the IRS requires that a majority of committee members not be in a position to exercise substantial influence over the affairs of the business, e.g., directors or officers of the business. Involving rank-and-file employees of the business to serve on a selection committee is not only permissible, but frequently a best practice to demonstrate the integrity of the decision-making process.

The Employee Relief Fund Must Maintain Proper Documentation

An employee relief fund must maintain adequate records to show that its payments further its charitable purposes and that the employees receiving payments are needy or distressed. Generally, the best practice is for an employee relief fund is to keep records of its charitable purposes and how the relief program achieves them, the criteria for relief, the selection process, the type of relief actually provided, and the name, address, and amount distributed to each recipient. More- detailed documentation is required for the provision of longer-term assistance as opposed to short-term emergency relief.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Richard L. Fox is a shareholder and attorney in the Philadelphia office of Buchanan Ingersoll & Rooney, PC, where he writes and speaks frequently on issues pertaining to philanthropic planning. Richard can be reached at (215) 665-3811 and richard.fox@bipc.com. Joshua D. Headley is an associate and attorney in the Washington, DC office of Buchanan Ingersoll & Rooney, PC.

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