After the terrorist attacks on September 11, 2001, Congress added a little-known tax provision to the tax law. This little-known tax code provision exempts certain payments from taxation during a disaster or terrorist attack.
President Donald Trump’s national emergency declaration triggered the disaster provisions of the tax law, including this one—where both you and your employees can reap benefits during this COVID-19 pandemic.
How This Works
Because of the pandemic, the tax code makes the following tax-free to your employees:
- Payments they receive from you for necessary personal, family, living, or funeral expenses incurred as a result of COVID-19
- Payments they receive from you for reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence, or for the repair or replacement of its contents, to the extent that the need for such repair, rehabilitation, or replacement is attributable to COVID-19
The qualified COVID-19 disaster relief payments are free of income tax, payroll taxes, and self-employment tax. Not only are the payments tax-free to your employee, but they are deductible to you as a business expense, regardless of whether or not the payment ends up being tax-free to the employee.
Payments That Do Not Work
The exclusion from income does not apply to payments in the nature of income replacement, such as payments to individuals for lost wages, unemployment compensation, or payments in the nature of business income replacement.
Payments to business entities don’t qualify, either. Qualified disaster relief payments do not include payments for any expenses compensated by insurance or otherwise.
Payments You Can Make
Here’s an example: the IRS ruled that grants received by employees under an employer program to pay or reimburse reasonable and necessary medical, temporary housing, or transportation expenses incurred as a result of a flood qualify for this benefit.
With respect to the COVID-19 pandemic, you could reimburse or pay for the following employee expenses under this guidance:
- Out-of-pocket medical costs not covered by health insurance
- Teleworking costs, such as a computer, office equipment, telephone, and supplies
- Funeral costs for an employee or an employee’s family member
- Childcare costs so that your employees can continue to work while children are home from school
Planning note. Because of the Tax Cuts and Jobs Act, employees may not deduct employee business expenses during tax years 2018-2025, so your reimbursement of such expenses under the disaster rules is extra valuable.
Here’s a surprise: Congress doesn’t think taxpayers can account for their actual expenses because they are going through a disaster, so taxpayers are in the clear provided the payments received and treated as tax-free are reasonably expected to be commensurate with the expenses they incurred.
Even if the IRS is generous with documentation requirements, we recommend you implement a formal, written plan with
- starting and ending dates of the program;
- a listing of the expenses you will pay or reimburse;
- the maximum payment per employee;
- maximum total payments through the plan; and
- a procedure the employee will use to request funds.
You should also track the names and amounts provided to each employee under the program terms.
During the COVID-19 pandemic, you establish a plan to help employees with telework expenses, allowing each employee to get a $1,500 grant for equipment, supplies, and use of home utilities.
Your employees Sam and Helen each apply, and each estimate they will spend $1,500 on a form you provide. Sam and Helen each spend approximately $1,500 on telework equipment and supplies.
The tax results are as follows:
- You get a $3,000 tax deduction.
- Sam gets $1,500 completely tax-free.
- Helen gets $1,500 completely tax-free.
We specialize in helping clients clarify their taxes so they keep more of their money. Many small business owners who come to see us in Fort Worth, TX generally do not understand the tax law enough to explain it to a fifth grader.