Employers providing support to employees during the COVID-19 pandemic can do so without triggering tax requirements in many cases — but executives seeking to return compensation to the company to aid employees should be cautious.
“Qualified Disaster Relief Payments” are excludable from income (and therefore exempt from income tax) and not subject to payroll taxes.1 They include payments to reimburse or pay reasonable and necessary personal, family, living or funeral expenses in the event of a “qualified disaster,” if not otherwise compensated by insurance. A “qualified disaster” includes disasters declared by the President under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. President Trump made such a declaration on March 13, 2020 with respect to COVID-19.2
There is very minimal guidance on what qualified disaster relief payments include. They do not include replacement of wages or wage-like payments, such as sick leave or paid leave. Raises or bonuses to classes of workers (e.g., front-line employees or customer-facing employees) are not disaster relief payments.
While extensive accounting is not required, and putting in place an official ‘program’ may unnecessarily slow down needed relief to employees, we recommend a basic practical system to identify employee hardship and the general category of expenses paid (e.g., help with living expenses, help with funeral expenses, grocery assistance, etc.). Reimbursements and advances for expenses should both be allowed.
Employee COVID-19 Hardship Payments Should Be Deductible to the Employer
Even though such hardship payments are not taxable income to the employee, or subject to payroll taxes, they should remain deductible by the employer.
Be Thoughtful About Salary Reductions or Executive Give-Backs for Hardship Payments
Several of our clients have asked whether executives (e.g., the CEO) could return compensation or bonuses to the company to be used to make hardship payments for company employees, but not be taxed on the returned compensation or bonus. While all of the potential issues related to such a proposal are beyond the scope of this update, we have identified a few items meriting additional review.
This generous offer may conflict with established tax doctrines regarding receipt of income and its taxation. It is a facts-and-circumstances question, though if the executive is entitled to the compensation, even if has not been paid to him or her, it is likely the IRS would see the executive as having sufficient control over it to be subject to tax in his or her hands.3
A corresponding deduction might be available to the executive if the company has a foundation or other charitable arm, though significant restrictions may apply. More information on this and other employee assistance programs may be found here. Note that cash deduction limits have been removed by the CARES Act. Public companies should also consider what disclosures could be required.
It is possible that an executive who is taxed on compensation but returns it after tax to the company to make employee hardship payments could add the amount of the returned bonus to the basis in his or her shares as a contribution to capital of the corporation.4 While this would result in a timing and character difference for the executive, when compared to avoiding the income and tax at payment, or getting a full deduction, such position could allow the executive to lessen the total income tax cost of the generous payment and direct it back to the company to benefit employees suffering hardships.
1 See IRC § 139.
2 https://www.whitehouse.gov/briefings-statements/letter-president-donald-j-trump-emergency-determination-stafford-act/
3 Treasury Regulation § 1.451-2.
4 See IRC § 118; by analogy Treasury Regulation § 1.83-6(d).
