Hurricanes Harvey and Irma have wreaked havoc on the lives of thousands of Americans, leaving many looking for ways to assist those in need and achieve favorable tax treatment. The IRS has maintained historical guidance, and it made recent announcements that provide guidance for those individuals and employers looking to assist victims.
Employers Can Offer Tax-Free Assistance to Staff
An employer may provide assistance to employees affected by a presidentially declared disaster in a manner that is exempt from federal income and employment taxes. Providing assistance in cash or services is relatively straightforward and requires no substantiation from the employees, while still allowing the employer to deduct the payments. Because there are virtually no administration requirements, an employer can react very quickly to help alleviate its employees’ immediate needs.
The exclusion is provided by Internal Revenue Code (IRC) Section 139(a) and specifically exempts from gross income “Qualified Disaster Relief Payments” that are not compensated by insurance or otherwise. “Qualified Disaster Relief Payments” can be paid to, or for the benefit of, an individual to reimburse or pay reasonable and necessary expenses incurred:
- As a result of a qualified disaster for family, living or funeral expenses;
- For the repair or rehabilitation of a personal residence; or
- For repair or replacement of the contents of a personal residence — to the extent that the need for such repair, rehabilitation or replacement is attributable to a qualified disaster.
Revenue Ruling 2003-12 shows how this provision is particularly helpful after a hurricane, stating, “Payments that employees receive under an employer’s program to pay or reimburse unreimbursed reasonable and necessary medical, temporary housing or transportation expenses they incur as a result of a flood are excluded from gross income.” In addition, the rule explains that the amounts excluded from gross income under Section 139 are not subject to typical reporting requirements.
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Increased Access to Retirement Plan Funds
The IRS recently announced relaxed procedural and administrative rules that normally apply to retirement plan loans and hardship distributions, specifically for victims of Hurricane Harvey. Participants in 401(k) plans, 403(b) tax-sheltered annuities and 457(b) deferred-compensation plans sponsored by state and local governments may be eligible to take advantage of streamlined loan procedures and loosened hardship distribution rules designed to provide quicker access to their money. In addition, the six-month ban on 401(k) and 403(b) contributions that normally affects employees who take hardship distributions will not apply. While IRA participants are not allowed to borrow from the IRA, they may be eligible to make IRA withdrawals under liberalized procedures.
Not only does this broad-based relief apply to victims of hurricanes, it also applies to a person who lives outside the disaster area, takes out a retirement plan loan or hardship distribution and uses it to assist an immediate family member or other dependent who lived or worked in the disaster area.
Plans will be allowed to make loans or hardship distributions before the plan is formally amended to provide for such features. In addition, the plan can ignore the reasons that normally apply to hardship distributions, thus allowing them, for example, to be used for food and shelter. If a plan requires certain documentation before a distribution is made, the plan can relax this requirement. To qualify for this relief, hardship withdrawals must be made by January 31, 2018.
Before accessing retirement funds, it is important to remember that the relaxed procedures have not changed the tax treatment of loans and distributions. Retirement plan loan proceeds are tax-free if they are repaid over a period of five years or less and hardship distributions are generally taxable and subject to a 10-percent early-withdrawal tax unless one of several exceptions is satisfied.
Employee Donations of Leave
The IRS also recently issued Notice 2017-48, which indicates they will not assert that cash payments an employer makes to a charitable organization in exchange for vacation, sick or personal leave that its employees elect to forgo constitute gross income or wages of the employees if the payments are: (1) made to the charity for the relief of victims of Hurricane Harvey and Tropical Storm Harvey; and (2) paid to the charity before January 1, 2019. The employee does not take the money into income and therefore does not get a charitable deduction.
IRC 501(c)(3) status for disaster relief organizations
When considering natural disasters like Harvey or Irma, a company may want to donate to an existing charity, or they may want to form a new charity. If an employer forms a new charity, it should be sure the assistance is geared towards a class of persons broad enough to constitute a “charitable class.” In other words, assistance cannot simply be for a single family or an individual. Even if the group is smaller and limited to a particular group of employees or franchisees, the group could still qualify as a charitable class if the group is indefinite and open ended, such as one that includes victims of a current or future disaster. If a new organization applies to the IRS for 501(c)(3) status, it could be eligible for an expedited review of the application.
Existing organizations qualified under section 501(c)(3) could get involved in disaster relief activities that accomplish charitable purposes — even though those activities were not described in its exemption application, without first obtaining permission from the IRS. However, it should report new activities on its annual return.
Public charity or private foundation?
If the organization qualifies as a 501(c)(3) organization, a determination must be made as to whether the organization is a public charity or a private foundation. Employer-sponsored private foundations can make payments to employees for certain “qualified disasters” that the Secretary of the Treasury has specified. On the other hand, public charities can make payments under broader circumstances, like other disasters or employee emergency hardships. Classification as a public charity will depend on whether there is broad-based public support for the organization, as opposed to a few individuals or a company making the major contributions. In some cases, an organization can be classified as a public charity if it supports another public charity, such as a community foundation.
When companies form new organizations to help employees who encounter disasters, it may be possible to show broad public support if other employees make donations. Even though these employees are associated with the company, they still may be considered the general public when it comes to their individual donations, allowing the organization to qualify as a public charity.
See also: Hurricane Harvey: A Moment of Truth
Employers cannot excessively control a public charity
In addition to the charitable class requirement, an employer cannot excessively control a public charity, nor can the organization impermissibly serve the related employer’s private interests. Recipients should be chosen based on an objective determination of need or distress and should be selected by a group independent of the employer so that any benefit to the employer is merely incidental.
If these requirements are met, the public charity’s payments — even if those payments are to employees and their family members — are considered payments for charitable purposes and, thus, are not considered taxable income.
For more information
This is just a short summary of what companies and organizations need to keep in mind the next time disaster strikes and they wish to extend a helping hand. Companies should review IRS Publication 3833 for more information.
Additional resources concerning other tax relief, specifically related to Hurricane Harvey and Hurricane Irma, can be found on the IRS disaster relief page. For information on government-wide relief efforts, visit www.USA.gov/hurricaneharvey or www.USA.gov/hurricane-irma.