A rarely utilized and lesser-known provision in the Tax Code, section 139, permits employers to reimburse employees for certain personal expenses incurred as a result of a “qualified disaster.”
Sec. 139 was added to the Code after September 11, 2001 to encourage employers to help employees affected by the terrorist attacks. It has since been used in conjunction with natural disasters (i.e., hurricanes and earthquakes) as well as the Ebola virus outbreak.
If the payments meet certain requirements, then the following tax benefits are available: a) the reimbursements or payments are excluded from the employee’s gross income; b) the employer is permitted a corresponding deduction; and c) the payments are excluded from both the employee’s and the employer’s payroll tax.
To qualify for these tax benefits, the reimbursement or payment must be for an expense that is incurred as a result of a “qualified disaster.”
A qualified disaster includes any disaster determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Relief and Emergency Assistance Act (the “Stafford Act”).
On March 13, 2020, in response to the COVID-19 pandemic, President Trump declared a national emergency under the Stafford Act and instructed the IRS to delay the April 15th tax deadline. Therefore, the COVID-19 pandemic is very likely a “qualified disaster” under the statute and certain expenses incurred as a result of the pandemic should qualify for the tax benefits. The IRS may release an official notice or announcement to this effect (as it has done in the past in this context) but has not done so yet.
To qualify, the payments must be made to reimburse or pay “reasonable and necessary” personal, family, living, or funeral expenses incurred as a result of the pandemic. Such expenses include personal property expenses, as well as medical, housing, and transportation expenses.
Determining whether an expense is “reasonable and necessary” requires a careful consideration of the facts, such as the amount of the payment, the reason for the payment, and other circumstances.
For example, a payment made to reimburse an employee for childcare costs incurred as a result of school or daycare closures may qualify under this definition. Similarly, costs incurred by an employee to rent or buy additional space or equipment to work from home due to the “shelter in place” order may also qualify.
As with all tax benefits, certain limitations are in place. First, wages voluntarily paid by an employer while a business is closed would not qualify because Sec. 139 does not apply to “income replacement payments” (i.e., lost wages or unemployment). Moreover, a payment does not qualify if the expense is also compensated by “insurance or otherwise.”
Second, to prevent a double benefit, the employee cannot also claim a deduction or credit for, or by reason of, the expense for which an amount is excluded under Sec. 139. For example, if an employer reimburses an employee $2,500 for out-of-pocket medical expenses incurred as a result of the pandemic, then the employee cannot also claim a $2,500 deduction on his personal return for that expense. If the total cost to the employee was instead $4,000, then the employee could deduct the excess (i.e., $1,500).
To claim the Sec. 139 income exclusion, the IRS will not require individuals to account for actual disaster-related expenses unless the amount of the payment seems unreasonable in relation to the expense incurred. Nevertheless, employees should maintain documentation if a need for substantiation does arise.
Moreover, employers that are interested in reimbursing employees for pandemic-related expenses under this provision should establish a “plan document” that outlines the appropriate procedures for requesting and approving the payments. For examples of what to include in such a plan, please review Rev. Rul. 2003-12 or contact any of the persons below.
For any tax-related questions specific to this Tax Alert or to find out if you qualify for the Sec. 139 tax benefits, please contact any of the following individuals:
