Since March 2020, many employers have scrambled to find ways to help employees deal with hardships caused by the pandemic. Whether employees are dealing with problems caused by the pandemic and natural disasters or confronting more personal issues--such as an illness in the family or challenges with childcare--employers understandably want to help their people deal with setbacks. But some employers and employees don’t understand the rules related to providing such assistance and have been surprised to learn of the potential tax implications of providing financial support to team members.
Now that we have moved into the next stage of pandemic recovery, it is a good time to review the ways employers can help employees, so they are better prepared for the next crisis. We describe five ways that employers can provide financial assistance to employees in challenging times.
In March 2020, President Trump declared the COVID-19 pandemic a national emergency. That declaration triggered the use of Internal Revenue Code (IRC) Section 139, which allows employers to make tax-free, tax-deductible qualified disaster relief payments or reimbursements to employees. Those payments include any COVID-19-related personal, family, living or funeral expenses, as well as reimbursement or payment for necessary expenses related to the repair of a personal residence attributable to a qualified national disaster. Payments that qualify under IRC Section 139 are tax-free for employees and generally tax-deductible for employers.
The rules for paying Section 139 expenses aren’t very onerous. Employers don’t need a written plan, although it is a good idea to have one to explain the program to employees. Recipients also don’t need to provide receipts or other proof of expenses, but employers may want employees to sign a document that describes the nature of the expense and the amount. Also, unlike many other employee benefit programs, Section 139 does not require non-discrimination testing, so employers can provide different amounts to different employees.
IRC Section 7872(c) allows employers to make interest-free loans of up to $10,000. If an employee already has a loan from the employer, the employer can make an additional loan if the interest rate is at least equal to the applicable federal rate. Loans are not taxable wage income unless repayment is forgiven. If the employer forgives the loan, then the amount forgiven is subject to income and employment taxes, as if it were a cash bonus.
Employers can establish PTO banks through which employees donate their unused PTO to others for one of two IRS-approved reasons: medical necessity and in response to a natural disaster. In this setup, employees donate available PTO hours to a PTO bank, and an employer-sponsored committee determines the rules for who receives donated hours, as well as the process for paying them out. Note that employees who donate hours can’t designate who will receive those donated hours; that decision is made by the employer and subject to the rules of the plan.
For PTO donations, employers must have a written plan outlining the program and the application and distribution process. When these programs are set up correctly, only the employee who receives the donated PTO hours will pay income and employment taxes on those PTO hours, based on their regular rate of pay. But when they aren’t set up correctly, both the employee donating the PTO and the recipient could pay income and employment taxes, and the employer may be on the hook for its share of FICA payroll taxes on both ends.
In many instances, employees may want to “pass the hat” to raise money for colleagues dealing with challenging circumstances. This activity is acceptable in a work environment, and employers can even choose to serve as the “middleman” for a short period of time if they want to help, including pooling cash donations in a separate bank account that is clearly earmarked for this purpose. But keep in mind that only employee-to-employee giving is acceptable in those circumstances and all funds donated by employees are made with after-tax dollars.
Employers that are interested in greater flexibility to provide financial assistance to employees may want to consider setting up a charitable foundation in the form of an IRC Section 501(c)(3) organization. Once certain conditions are met — including creating a selection committee, establishing objectives for the charity and identifying a group of potential beneficiaries—employers and employees can make tax-deductible contributions to the foundation. Selected recipients receive this financial assistance as a tax-free gift.
The main downside to this approach is the amount of time and resources required to establish a charitable foundation. Getting approved by the IRS for tax-exempt status, for example, historically takes at least six months, and delays in the application and approval process are very common. There are also annual reporting requirements, fees and other administrative issues when establishing a Section 501(c)(3) organization.
Insight: Get your employee-assistance house in order before the next crisis hits
Perhaps now more than ever, employers have first-hand knowledge of the personal challenges their employees can encounter, and many want to be prepared to provide financial assistance to team members. But these programs take time and resources to implement in a way that is manageable and compliant with existing tax law.
Don’t wait until the next disaster hits to have your workplace financial assistance programs and policies in place.