Employers may make tax-free payments to employees for COVID-19 expenses
In addition to the expanded sick pay and family medical leave benefits for employees under the Families First Coronavirus Response Act (discussed here and here) and the tax incentives and relief included in the CARES Act (discussed here and here), employers have an additional tax-related tool to support their employees affected by the COVID-19 pandemic. Existing law allows employers to make “qualified disaster relief payments” to their employees that are tax-free to the employee.
On March 13, 2020, President Donald Trump declared a federal disaster under the Robert T. Stafford Disaster Relief and Emergency Assistance Act in connection with the COVID-19 pandemic. This declaration allows employers to make tax-free disaster relief grants to their employees under Section 139 of the tax code to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of the pandemic, so long as such expenses are not covered by insurance or are intended to replace lost income. Section 139 has not previously been applied in the context of a pandemic, so the scope of allowable payments remains open to interpretation. Still, payments for medical expenses of the employee for COVID-19 treatment not covered by insurance or funeral costs of an employee or employee’s family member who died from the virus should qualify as tax-free employer grants. Furthermore, costs associated with employees working from home to observe social distancing such as home office supplies and for childcare or tutoring due to pandemic-related school closures should qualify. However, payments of sick pay or for family medical leave would not qualify for tax-free treatment.
An employer may choose to make disaster relief payments to any employee and there are no requirements for how long the employee has been employed or to treat all employees in the same way in making these payments. Although a formal plan is not required, it would be prudent for an employer to document items related to payment programs (e.g., the amounts paid and to whom, starting and end dates of the program, and the types of expenses that the program will cover) to support the tax treatment of the payments made.
Employers making disaster relief grants to employees should keep in mind that not all states conform to the federal rules. Accordingly, employers may want to seek advice from a state tax professional regarding the implications of these federal provisions for state tax purposes before making disaster relief payments.