As we previously reported, charitable organizations are able to play an important role in providing disaster relief in response to the COVID-19 crisis. Special rules are relevant to employers that wish to provide hardship support to their current and former employees during this time. In light of the unique nature of this crisis, additional guidance may be forthcoming from the IRS.
Employers that wish to provide support using tax-exempt vehicles—including public charities, private foundations and funds held at community foundations or donor-advised fund sponsoring organizations—need to structure their programs in ways that avoid providing impermissible private benefit to the employers themselves. In addition to ensuring that their giving programs serve a charitable class (as we described in our earlier post), employer-sponsored relief programs should not be structured to advance employee recruitment and retention or for senior executives to exercise complete control over the selection of aid recipients. Applicable rules vary depending on the tax-exempt vehicle employers use to provide disaster relief.
Both employer-sponsored public charities and employer-sponsored private foundations can provide aid to a charitable class consisting of a “large” or “indefinite” class of beneficiaries as long as recipients are selected based on an “objective determination of need.” In addition, in order to ensure that any benefit to the employer is incidental, the aid recipients need to be selected by an independent selection committee or procedures must be put in place that provide for such independence. To achieve independence, a majority of the members of any selection committee cannot be individuals who are in a position to exercise substantial influence over the affairs of the employer.
Additional rules apply to employer-sponsored private foundations. Such foundations:
- may only provide disaster relief funds to employees or their family members in connection with a “qualified disaster.” Section 139 of the Internal Revenue Code defines a qualified disaster as, among other things, a federally declared disaster (when the President signed a proclamation on March 13, 2020 declaring a national emergency concerning COVID-19, the current crisis was designated as a qualified disaster);
- remain subject to the restrictions on self-dealing under Code Section 4941, which means that assistance cannot be provided to disqualified persons such as directors, officers, and substantial donors (and certain family members of such persons), as well as members of the selection committee; and
- cannot use a disaster relief program to induce an employee to follow a particular course of action supported by the employer (such as recruiting) or to relieve the employer of a legal obligation with respect to employee benefits (such as a collective bargaining agreement or written plan providing insurance benefits).
Finally, employers may establish disaster relief funds at donor-advised fund sponsoring organizations and community foundations to provide aid to employees and their family members in connection with a qualified disaster. In general, a donor-advised fund includes all accounts and funds at a community foundation or other public charity over which the donor (or anyone appointed by the donor) has or reasonably expects to have advisory privileges. Further, distributions to individuals by donor-advised funds are generally subject to an excise tax under Section 4966 of the Code. However, under Code Section 4966(c)(2), the Internal Revenue Service and the Department of Treasury have exempted from the definition of donor-advised fund any employer-sponsored relief fund that meets the following requirements:
- the fund serves a single identified charitable purpose, which is to provide relief from one or more qualified disasters (including but not limited to a federally declared disaster);
- the fund serves a charitable class (which is “large” or “indefinite”);
- recipients of grants from the fund are selected based on “objective determinations of need”;
- the selection of recipients of grants from the fund is made using either an independent selection committee or adequate substitute procedures to ensure that any benefit to the employer is incidental and tenuous (as above, the selection committee is independent if a majority of the members of the committee consists of persons who are not in a position to exercise substantial influence over the affairs of the employer);
- no payment is made from the fund to or for the benefit of (i) any director, officer, or trustee of the sponsoring organization of the fund, or (ii) members of the fund’s selection committee; and
- the fund maintains adequate records that demonstrate the recipients’ needs for the disaster relief assistance provided.
Accordingly, an employer-sponsored relief fund housed at a sponsoring organization or community foundation that meets the above criteria will not be subject to excise taxes for making distributions to individual employees or their family members.
Tax Implications for Recipients of Disaster Relief Assistance
If employers choose to provide disaster relief through tax-exempt organizations as described above, under Code Section 102 the payment is generally considered a gift for the recipient and is not included in taxable income.
In the current crisis, payments made by employers directly (as opposed to through tax-exempt organizations) are generally also not included in taxable income. Under Code Section 139, “qualified relief payments” (including those from for-profit employers) are excluded from gross income. A qualified relief payment is defined as any amount paid to or for the benefit of an individual:
- to 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; or
- if such amount is paid by a Federal, State, or local government, or agency or instrumentality thereof, in connection with a qualified disaster in order to promote the general welfare.
Note, however, that qualified relief payments are excluded from taxable income only to the extent that (i) any expense compensated by such payment is not otherwise compensated for by insurance or otherwise and (ii) such payments do not constitute income replacement payments (such as payments of lost wages, business income, or unemployment compensation).