With hurricane season upon us, employers may be considering how they can help employees if disaster strikes. For employers desiring to aid employees affected by a disaster, there are a number of avenues available to assist during these times. However, employers should be aware of the tax implications of such assistance.
Transfer of Paid Time Off
Leave banks, where employees donate their unused accrued paid time off (“PTO”) into a pool for other employees to use during times of need, are a common practice. In standard leave-sharing programs, the employee who is donating the leave is still subject to income tax. The rationale for imposing tax on the giver is that the leave is considered the giver’s benefit and thus it is included in their taxable gross income.
The taxation rules differ, however, when there is a federally declared “major disaster” in order to help alleviate the burden of the disaster on employees in need. Under IRS Notice 2006-59, certain leave-sharing programs can provide for favorable tax treatment. A leave-sharing program involves PTO that is donated to a pool and used specifically during major disasters. A “major disaster” means: (a) a major disaster declared by the President under § 401 of the Stafford Act, 42 U.S.C. § 5710 that warrants individual assistance or individual and public assistance from the federal government under that Act; or (b) a major disaster or emergency as declared by the President pursuant to 5 U.S.C. § 6391, in the case of employees described in that statute. In addition to requiring a major disaster, Notice 2006-59 lays out various other requirements that must be met in order for a leave-sharing program to qualify under the Notice, such as the recipient being required to suffer a “severe hardship” and the employer being required to make a “reasonable determination” as to how much leave a recipient can obtain under the program. For a leave-sharing program that meets the specific requirements laid out in Notice 2006-59, the employee who donates the time is not taxed; however, the leave recipient is taxed on the leave as part of their gross income.
Alternatively, an employer can choose to establish a PTO charitable donation program. Here, an employee can donate their leave to the employer who then converts the time into cash payments that the employer can donate to a charitable organization. The money donated to the charitable organization is not distributed to employees directly, but rather to a qualified area affected by the disaster. For a standard charitable donation program, donating PTO results in a taxable event for the donating employee, similar to the leave bank discussed above. However, there may be an exception if the IRS issues guidance regarding a disaster relief charitable donation program that specifically waives this “assignment-of-income doctrine.” Such notices are disaster-specific and will generally state that employees who surrender PTO to a charitable organization for the relief of victims of a certain disaster will not be required to recognize compensation income. An example of this is the IRS guidance that was issued on November 19, 2018 for leave-based donation programs to aid victims of Hurricane Michael. Under Notice 2018-89, if an employer makes cash payments: (1) to charitable organizations described in Internal Revenue Code § 170(c) for the relief of victims of Hurricane Michael; and (2) to such charitable organizations before January 1, 2020, neither the employee donating their leave nor the employee receiving the aid must recognize taxable income. Additionally, an employer can deduct the donation as a business expense, relieving their own tax burden of participating in the relief program.
Philanthropic employees can also elect a payroll deduction in order to give money directly to another employee. Here, the employer merely acts as an agent to deduct the donation and distribute it to affected employees, but these funds must be kept separate from any employer funds. It is common to have an isolated account set up for these employee-to-employee donations.
In this situation, because the distribution is treated as a gift, there are no negative tax consequences to either the donor employee or to the employee receiving the funds, unless the amount exceeds the allotted IRS gift threshold for the given year.
Direct Payment from Employer to Employee - U.S. Code § 139
While, as noted above, employee-to-employee gifts within the gift threshold are tax free, employer matches of employee gifts or other direct gifts from the employer are typically treated as gross income to the recipient. However, under Internal Revenue Code § 139, employer contributions receive favorable tax treatment if the payments are “qualified disaster relief payments.”
In order for employer contributions to be deemed qualified disaster relief payments, the employer contributions must meet the following requirements: 1) the payments must be used for disaster relief that is not otherwise covered by insurance; 2) the employee receiving the funds must live in a declared disaster zone; and 3) the payments must be “qualified disaster relief payments.” A “qualified disaster relief payment” means any amount paid by the employer to, or for the benefit of, an employee to reimburse or pay “reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster” or “reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation, or replacement is attributable to a qualified disaster.” A “qualified disaster” is one defined in Internal Revenue Code § 139(c) and includes a federally declared disaster. An example of such a disaster is Hurricane Michael, which was deemed a federally declared disaster in 2018. For qualified disaster relief payments that meet the above rules, such payments are not included in the recipient employee’s gross income.
Private Foundations and Public Charities
Another method of assisting employees in need is to establish an employer-sponsored charitable organization under Internal Revenue Code § 501(c)(3) that focuses its efforts on disaster relief activities for affected employees. The organization can be used to distribute money to those in need, while also receiving the tax benefits associated with a charitable organization, including tax deductions for individual donors and businesses (including the employer), tax relief for recipients of the charitable aid, and tax exemptions for the charitable organization itself. However, such an organization must serve a “charitable class,” meaning, in this case, that the organization must assist an indefinite class of employees (i.e., employees who are victims of all disasters, present and future, and not just those affected by a current disaster). Thus, an employer should keep in mind when deciding whether to establish a charitable organization that the organization would need to maintain ongoing philanthropy and offer relief besides that associated with only one specific disaster in order to maintain its status as a 501(c)(3) organization.
Alternatively, an employer can also establish a private foundation under 501(c)(3), which is subject to different restrictions than a public charity. A private foundation, which typically has a single major source of funding (in this case, the employer), is more restricted on the type of assistance it can provide; like the employer itself, it is generally limited to providing qualified disaster relief payments to employees under Internal Revenue Code § 139(c). In contrast, if the employer establishes a public charity, which typically solicits funds from the general public, the organization will be less restricted in the type of assistance it may provide. Not only can a public charity respond to national disasters, it can also assist with employee emergency hardship situations, which could encompass a fire, illness, death in the family, and various other hardships. Finally, as an alternative, it may simply be more practical to combine with an existing charity to provide relief aimed at addressing a particular disaster situation.
Contribution by Kayleigh Wood