As the COVID-19 pandemic spreads, the economy has struggled significantly under its new burdens. The impact both domestically and globally has been staggering, and many employers are interested in finding creative solutions to assist their workers. Several existing mechanisms allow employers to provide some measure of economic relief to their employees. In addition, current developments have increased methods available to provide assistance.
This alert will address various strategies employers (both charitable and for-profit) can follow to assist their employees and the communities in which they operate.
Payments by Employers
Employers may make payments directly to their employees. While normally payments to employees are taxable as compensation, if the payment is a “qualified disaster relief payment” it is not subject to federal income or employment taxes. A qualified disaster relief payment is generally a payment made to compensate the employee for certain expenses incurred as a result of a “qualified disaster.”
A qualified disaster, as defined by Section 139 of the Internal Revenue Code, includes, among other things, a federally declared disaster. The term “federally declared disaster” means any disaster that is determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. On March 13, 2020, President Trump issued a nationwide emergency declaration due to COVID-19 under the Stafford Act.
Previous IRS guidance indicates that the President’s emergency declaration will allow employers to make qualified disaster relief payments to their employees, to help ease the burden from certain COVID-19-related expenses, without the payments being treated as compensation or taxable income for federal purposes to the employees. In addition, the IRS has indicated in informal guidance on its website that the COVID-19 pandemic is a qualified disaster.1
Qualified disaster relief payments are intended to support those affected by a disaster. Employees will be able to use the payments to pay only for reasonable and necessary personal, family, living, or funeral expenses incurred as a result of the COVID-19 pandemic. Employers should note that payments intended to replace wages or compensation that the employee would otherwise earn (including sick leave or other paid time off) do not constitute qualified disaster relief payments. In addition, payments cannot be made to relieve expenses paid for by insurance or that are otherwise similarly reimbursed.
A for-profit employer that makes a qualified disaster relief payment can claim a deduction for the amount paid. The employee recipient is not taxed on that amount.
Employers wishing to provide relief that does not qualify as a qualified disaster relief payment may do so, such as payments to employees to mitigate lost wages. However, employers should be aware that these payments will constitute additional compensation to the employee, which will be subject to income tax withholding and employment taxes. In either case, the amount paid will normally be deductible by the employer.
Employers can create a non-tax-exempt separate fund if other employees or third parties are interested in contributing. These types of funds are usually operated by the employer and can accept contributions from both the employer and employees, as well as others.
The mechanics of these types of funds are often misunderstood, and employers should clarify with their employees that:
- employees receiving support from the fund may have to pay taxes on the awards, unless the awards are qualified disaster relief payments, and
- contributions to the fund will be made from after-tax dollars and are not deductible by donors.
This structure does not offer robust tax benefits, but it can boost employee morale by creating a unifying structure for providing assistance to co-workers. It is relatively easy to establish and may be an especially attractive option if an employer does not have access to an existing charitable organization.
If an employer would like to provide additional benefits in a more tax-efficient manner for affected employees or is interested in allowing other employees or third parties to potentially receive a tax benefit for their contributions, the employer could consider organizing or partnering with a charitable organization, as discussed below.
Employer Giving Through Charitable Organizations
Employer-Sponsored Private Foundations
Many employers have created their own private foundations, usually funded primarily by the employer, which contribute to the health and vitality of their communities. Generally, private foundations can make need-based distributions to victims of disasters or to the poor or distressed without tax consequences to the recipient, but such foundations are subject to additional restrictions when this aid benefits the employees of the sponsoring employer. In this context, the grant must be made to employees affected by a qualified disaster. As discussed above, the COVID-19 pandemic is a qualified disaster. In addition, certain safeguards must be in place to ensure that such assistance is serving charitable purposes.
Employer-sponsored private foundations can make payments to employees or their family members affected by a qualified disaster if:
- the class of beneficiaries is large or indefinite,
- the recipients are selected based on an objective determination of need,
- the selection is made using an independent selection committee or adequate substitute procedures are in place, and
- payments are not made to or for the benefit of directors/trustees, members of the selection committee or their family members.
Employers should pay particular attention to the requirement that a class be large or indefinite. If the employer-sponsored private foundation supports only its own employees, the group of persons eligible for assistance must be indefinite. To be considered to benefit an indefinite class, the proposed relief program must be open ended and include employees affected by the current disaster and those who may be affected by a future disaster. The key goal is to prevent only an identifiable small group of individuals from receiving benefits. If a private foundation meets the requirements described above, grants to the affected employees will not be taxable to the recipients.
As stated above, employers usually fund their own company foundations, but when disaster strikes they may wish to accept contributions from employees and others. Donors’ contributions to the private foundation may be tax deductible, but individual donors who do not itemize deductions may not receive a tax benefit from the contribution. It is worth noting that the CARES Act, enacted on March 27, 2020, creates additional federal tax incentives for charitable giving (described below), including an above-the-line charitable contribution deduction for individuals who do not otherwise itemize deductions and increased deduction limitations for other individuals and corporations, but those additional incentives do not apply to contributions to most private foundations.
While qualified disasters may loosen the private foundation restrictions on providing benefits to employees, the IRS can still review grants to investigate and ensure that the benefits to the employer are only incidental and tenuous. The entirety of the facts and circumstances must demonstrate that payments are made principally to assist those suffering from the qualified disaster.
Partnership with Donor-Advised Funds or Public Charities
Employers interested in providing assistance without creating their own foundation can work with a donor-advised fund such as those established by community foundations or financial institutions. These funds allow a donor to support a charitable organization while retaining a certain level of advisory capacity. While the fund has sole control over how relief payments are ultimately made, it can take into consideration advice from the donor.
Typically, a donor-advised fund cannot provide benefits to any single individual. But there is an exception for employer-sponsored funds that are established to provide relief to employees and their family members who are victims of a qualified disaster. In this context, grants to employees and family members are permitted if:
- the fund serves the single identified purpose of providing relief from one or more qualified disasters as provided by Section 139 of the Internal Revenue Code,
- the fund serves a charitable class,
- recipients of grants are selected based upon an objective determination of need,
- the selection of recipients of grants is made using an independent committee, and
- no payment is made from the fund to key employees, officers, or members of the charity, sponsoring business, or committee.
Contributions to the fund qualify for a charitable deduction, and distributions to individuals in need will be tax-free. In general, the additional incentives for charitable giving enacted under the CARES Act do not apply to contributions to donor-advised funds. However, employer-sponsored relief funds that meet the requirements described above are not treated as donor-advised funds for this purpose, so sponsoring employers and other donors may benefit from the additional incentives under the CARES Act (described below).
An employer invested in the well-being of the entire community, which likely would include its current employees and their families, may consider working with a public charity. Ideally experienced operating in a particular geographic area, the charity could efficiently allocate contributions for the greatest benefit. The employer should not have control over the charity’s operations. This method, while not solely focused on specific employees, nonetheless benefits an entire affected area and could likely help the employees living within it.
Contributions to the charity will be tax deductible. As noted above, the CARES Act created additional incentives for charitable giving by enacting an above-the-line federal charitable contribution deduction of up to $300 for individuals who do not otherwise itemize deductions and increasing the deduction limitations for individuals who itemize deductions (from 60% to 100% of adjusted gross income) and for corporations (from 10% to 25% of taxable income) for qualified contributions in 2020. Qualified contributions include contributions to public charities, as well as contributions to employer-sponsored relief funds (described above). Further information regarding these deduction changes can be found here.
Relief for International Employees
Many businesses operate globally and have employees throughout the world. Employers interested in assisting their employees worldwide can make direct payments to affected employees as described above, but the tax consequences of these payments to non-U.S. employees generally will depend on local tax laws. Payments made to U.S. citizens working abroad generally will also be subject to U.S. tax laws. Employers should consult U.S. and local foreign counsel to determine the best way to provide direct assistance to non-U.S. employees.
Employers may partner with foreign charities, either directly or through a U.S. charity. Treatment of contributions from a taxable employer directly to a foreign charity (or earmarked for a foreign charity) generally are not tax deductible for U.S. income tax purposes, except as permitted under specific tax treaties between the United States and certain foreign countries.
Company private foundation grants to non-U.S. charities or individuals are generally subject to the private foundation rules under the Internal Revenue Code, including the requirement that the grantor exercise expenditure responsibility over the grant. As a result, most U.S. private foundations tend to limit non-U.S. beneficiaries to foreign charities that can demonstrate that they are the equivalent of a U.S. public charity. U.S. public charities can, in many circumstances, make distributions directly to non-U.S. charities, and even to individuals in some cases. They must have documented oversight and reporting requirements in place.
Many established private foundations and public charities are experienced with international grantmaking in general and disaster relief efforts in particular. Employers should consult with counsel before taking further steps.
CARES Act: Additional Options for Employee Assistance
The CARES Act contains several provisions that provide employers with further options to assist their employees, including increased access to retirement plan funds and relief to help employers stay operational and make payroll obligations.
Employers of employees with student loans may be particularly interested in a new relief provision in the CARES Act. Employers may now provide an employee up to $5,250 in student loan repayment assistance in 2020 for loans incurred by the employee for the employee’s own education (not for family members), and the payment will not be included in the employee’s federal gross income. This mechanism will allow employers to relieve some financial strain from those employees currently burdened with student loans.