How Businesses Can Provide Tax-Free Financial Assistance to Employees
By Kimberly Loocke, Eric Wall, Julia Riechert, and Richard D. Harroch
In the wake of the COVID-19 pandemic and shelter-in-place orders, businesses are considering ways to assist employees and other workers who are financially burdened by the crisis. One simple and tax-favorable action is to make disaster relief assistance payments under Section 139 of the Internal Revenue Code.
Under Section 139, payments for personal, family, living, or funeral expenses incurred as a result of the COVID-19 pandemic are both tax-free to the individual recipients and tax-deductible expenses for the business. Payments are free of IRS reporting requirements and a plan can be quickly adopted with minimal expense.
Businesses large and small can take advantage of this favorable tax treatment to help their workers during these challenging times. With careful planning, even businesses that have had to reduce salaries or adopt furloughs may be able to implement such a financial assistance plan to help their hardest hit workers from the COVID-19 pandemic.
Section 139 payments are highly tax favorable
Section 139 payments are excluded from the recipient’s federal gross income and not otherwise treated as compensation or income from self-employment, and are deductible by the business for federal income tax purposes (except to the extent self-employed individuals and other owner-employees receive a benefit as a recipient of a qualified disaster relief payment).
A broad variety of expenses may be covered by Section 139
Qualified disaster relief payments include 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. Qualifying payments may be structured as a reimbursement of actual expenses incurred by the recipient or as payments determined by the business to be in proportion to the recipient’s reasonable and necessary expenses incurred.
There is no dollar cap on qualifying payments, but they cannot be (1) made for nonessential, luxury or decorative items or services; (2) made for expenses which are otherwise compensated for by insurance or other sources; or (3) intended to replace lost wages or income.
Section 139 payments have low administrative and compliance requirements
Payments made pursuant to Section 139 are not required to be reported on a Form W-2 or Form 1099. These payments are not subject to any federal wage or other employment tax withholding obligations. Businesses should reach out to their tax advisors to confirm any state tax and withholding obligations.
A formal plan or policy to govern Section 139 payments is not required and a business is not required to obtain proof of the actual expenses incurred by the recipients as long as the business reasonably expects the amounts to be commensurate with the amounts of the individual’s unreimbursed reasonable and necessary expenses incurred as a result of the COVID-19 pandemic.
However, we recommend adopting a plan that describes the parameters and eligibility requirements for payments under the plan. Best practices also include obtaining an affirmative statement from the recipient that the funds received are necessary for expenses associated with COVID-19 and that such expenses will not be reimbursed by insurance.
Sample Employee Financial Assistance Plan
A variety of different approaches may be used to provide tax-favored financial assistance. Here is a sample Employee Financial Assistance Plan for a policy that provides reimbursements for documented COVID-19 expenses. This sample includes the recommended practices described above and should be tailored to your business’s particular situation:
COVID-19 Reimbursement Policy
This temporary policy establishes guidelines for Company reimbursements of employee expenses incurred due to the COVID-19 pandemic in accordance with Section 139 of the Internal Revenue Code. Subject to the conditions below, all Company employees who have incurred reasonable and necessary Covered Expenses within the Covered Period as a result of the COVID-19 pandemic may receive reimbursements of such expenses of up to $____ per employee.
Covered Expenses. “Covered Expenses” are expenses that are reasonable and necessary personal, family, living, or funeral expenses incurred as a direct result of the COVID-19 pandemic, reimbursement for which qualify as qualified disaster relief payments under Section 139 of the Internal Revenue Code, and which are not otherwise compensated for by insurance or otherwise. The Company will not reimburse costs of nonessential, luxury, or decorative items or services or make payments that are considered by the Company as replacement for lost wages, sick leave, or other income. Examples of expenses resulting from the COVID-19 pandemic that the Company will consider for reimbursement include:
Medical expenses not compensated for by insurance incurred as a result of a COVID-19 diagnosis or suspected COVID-19 infection
Precautionary health expenses, including hand sanitizer, face masks, gloves, and disinfectant cleaning supplies
Increased costs related to telecommuting due the COVID-19 pandemic, including initial and ongoing home office expenses, which are not otherwise reimbursed or covered by the Company
Increased travel and commuting costs incurred as a result of the necessity to use alternative travel and commuting arrangements due to the COVID-19 pandemic
Increased costs of child-care and educational expenses for immediate family members due to the COVID-19 pandemic
Reimbursement Procedures. Reimbursement requests must be submitted to ___________________ within 60 days of the date incurred, along with appropriate supporting documentation (e.g., a copy of receipts and a detailed itemized list of expenses incurred) and a certification that the expenses were reasonable and necessary expenses incurred as a result of the COVID-19 pandemic and are being requested in compliance with the conditions of this policy. Expenses for items or services the Company deems in its own discretion as nonessential, luxury, or decorative, or not incurred as a result of the COVID-19 pandemic will not be reimbursed. The Company will determine whether to reimburse for submitted expenses in its sole discretion. The employee must return to the Company any amounts received in excess of the substantiated expenses within 60 days from the date of reimbursement.
Payment Details. Reimbursement payments will be made as part the Company’s regularly scheduled payroll after receipt of the required documentation and completion of the Company’s approval process. The Company intends to treat qualifying reimbursements as non-taxable for federal employment and income tax purposes under Section 139 of the Internal Revenue Code, and the reimbursements will not otherwise be treated as compensation for purposes of the Company’s other benefit and incentive programs.
Covered Period. The “Covered Period” for this policy is March 13, 2020, through the date at which the COVID-19 pandemic is no longer considered a federally declared disaster or when the Company ends the policy, in its sole discretion. The Company reserves the right to modify or cancel this policy at any time.
Employee Expense Certification
Employee Name: _____________________________________________
Requested Reimbursement Amount: ________________________________
Expense Documentation Attached: YES
I certify that the requested reimbursement amount is for reasonable and necessary expenses incurred by me or my immediate family on or after March 13, 2020, as a direct result of the COVID-19 pandemic and is being requested in good faith pursuant to the Company’s COVID-19 Reimbursement Policy. I also certify the requested reimbursement amount is not intended to compensate for lost wages, sick leave, or income, and I did not and will not receive reimbursement or payment from any other source for the claimed expenses.
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About the Authors:
Kimberly Loocke is an experienced tax attorney in the San Francisco office of Orrick, Herrington & Sutcliffe. Kimberly focuses her practice on the tax aspects of corporate and real estate transactions, sales and use taxation, as well as tax controversy and operational matters. She has been recognized as a Rising Star by Super Lawyers from 2015-2019. Kimberly holds a Certified Public Accountant license and worked as a senior tax associate for Deloitte Tax, LLP. She can be reached through Orrick’s website.
Eric Wall is a partner in the San Francisco office of Orrick, Herrington & Sutcliffe, and is a member of its Tax Group. His practice encompasses a wide variety of federal and state tax issues, including domestic and cross-border mergers and acquisitions, executive compensation matters, real estate matters, and taxation of pass-through entities. He can be contacted through Orrick’s website.
Julia Riechert is an employment law partner and trial lawyer in the Silicon Valley office of Orrick, Herrington & Sutcliffe. She helps companies navigate and resolve challenging workplace issues and has extensive expertise in litigating and defeating employment claims. She can be reached through Orrick’s website.
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a venture capital fund in the San Francisco area. His focus is on internet, digital media, and software companies, and he was the founder of several internet companies. His articles have appeared online in Forbes, Fortune, MSN, Yahoo, FoxBusiness, and AllBusiness.com. Richard is the author of several books on startups and entrepreneurship as well as the co-author of Poker for Dummies and a Wall Street Journal-bestselling book on small business. He is the co-author of the 1,500-page book “Mergers and Acquisitions of Privately Held Companies: Analysis, Forms and Agreements,” published by Bloomberg. He was also a corporate and M&A partner at the Orrick law firm, with experience in startups, mergers and acquisitions, and venture capital. He has been involved in over 200 M&A transactions and 250 startup financings. He can be reached through LinkedIn.
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