In light of recent destruction and hardship wrought by Hurricane Harvey, numerous employers are asking whether they can offer disaster relief payments for employees affected by the storm. This can be complex, so this Alert serves to outline the rules for employers wishing to offer disaster relief to their affected employees directly or through employer-sponsored private foundations, public charities and donor advised funds.
Because of Hurricane Harvey, President Trump has declared that a major disaster exists for Texas and an emergency for Louisiana and FEMA has made the necessary formal declarations. Due to these disaster declarations under the Stafford Act, qualified disaster payments can be excluded from gross income and are not subject to federal income tax withholding or employment tax. Qualified payments can be made directly to employees under IRC §139 or through charitable organizations as explained below.
Section 139 qualified disaster assistance payments to employees
Employers can make tax-free “qualified disaster payments” directly to employees in the covered areas designated by FEMA without the need to create a private foundation, public charity or donor-advised fund. Such qualified disaster payments are not considered taxable income or subject to employment taxes or federal income tax withholding. Further, these payments are not subject to reporting on Form W-2 or Form 1099-MiSC.
IRS disaster relief guidance for employer-sponsored charities
Historically, employer-sponsored charitable organizations that were used to assist employees in their time of need were considered by the IRS to be tools to enhance employee recruitment and retention, and were thought to result in prohibited private benefit to sponsoring employers. The IRS was also concerned that employers could influence the selection of recipients. As a consequence, the IRS developed special rules to apply to employer-sponsored charities. The IRS guidance for providing disaster relief through charitable organizations is provided in IRS Publication 3833, Disaster Relief: Providing Assistance Through Charitable Organizations.
Some important highlights include:
1. The types of benefits a charitable organization can provide through an employer-sponsored assistance program depends on whether the employer-sponsored organization is a private foundation, public charity or a donor advised fund.
2. When an employer-sponsored organization provides assistance to employees, certain limitations apply that help to ensure that such aid does not result in impermissible private benefit to the employer.
3. An organization applying for recognition of exemption under IRC §501(c)(3) may request expedited handling of its application if it demonstrates that it is meeting an immediate need of disaster relief and that a non-expeditious review will adversely affect its ability to do so.
All three types of employer-sponsored charitable assistance programs discussed in Publication 3833 are briefly summarized below.
Employer-sponsored private foundations
Employer-sponsored private foundations must exercise care to ensure they make payments only to employees or their family members who are affected by “qualified disasters” as defined in IRC §139 (as opposed to non-qualified disasters or other emergency hardship situations) so they do not jeopardize their tax-exempt status. IRS Publication 3833 states that the IRS will generally presume that “qualified disaster” relief payments made by a private foundation to employees (or their family members) are consistent with the private foundation’s charitable purposes and not for the business purposes of the employer if the following requirements are met:
1. The class of beneficiaries is large or indefinite.
2. The recipients are selected based on an objective determination of need.
3. The selection is made using either an independent selection committee or adequate substitute procedures to ensure that any benefit to the employer is incidental and tenuous. The selection committee will be deemed independent if a majority of its members consists of persons who are not in a position to exercise substantial influence over the affairs of the employer.
If the requirements of this presumption are met, the private foundation’s qualified disaster relief payments: (1) are treated as made for charitable purposes, (2) do not result in prohibited self-dealing merely because the recipient is an employee (or family member of an employee) of the employer-sponsor and (3) do not result in taxable compensation to the employees. This presumption does not apply to payments that would otherwise constitute self-dealing (e.g., payments to individuals who are officers, directors, or trustees of the private foundation). The presumption also does not apply to payments made to members of the private foundation’s grant selection committee.
Finally, Publication 3833 notes that in each case, all of the facts and circumstances will be taken into account in determining whether a private foundation’s payments further charitable purposes. Therefore, satisfying all the requirements of the presumption, or failure to meet such requirements, is not necessarily determinative.
Employer-sponsored public charities
Since public charities are typically more transparent and are subject to a greater amount of public scrutiny due to their broad sources of financial support, they have more flexibility with respect to the assistance they may provide to employees than allowed for employer-sponsored private foundations or employer-sponsored donor advised funds. While they must still adhere to the three requirements set forth above when providing assistance to employees (to ensure the related employer does not exercise excessive control over the employee assistance organization), public charities may establish employer-sponsored employee assistance programs to assist in any type of disaster or hardship situation (i.e., qualified or non-qualified), so long as the employer does not exercise excessive control over the charity. If these requirements are met, the public charity’s payments to the employer-sponsor’s employees and their family members in response to a disaster or emergency hardship are presumed to be made for charitable purposes and will not result in taxable compensation to the employees.
Employer-sponsored donor advised funds
A donor advised fund (DAF) exists when a community foundation or other public charity maintains a separate fund or account to receive contributions from individual donors, and the donor receives advisory privileges over investment and/or distribution of the donated funds. Generally, DAFs may only make grants to other IRC §501(c)(3) public charities and cannot make grants to individual persons. However, there is an exception for certain employer-related funds or accounts that are established to benefit employees (or their family members) that are affected by a “qualified disaster” as defined in IRC §139.
In addition to the three requirements set forth above with respect to both private foundations and public charities, the DAF must be established to serve the single identified purpose of providing relief to employees and family members of the employer sponsor from one or more qualified disasters. Also, similar to the requirements of employer-sponsored private foundations, the DAF may not provide a benefit to any director, officer or trustee of the sponsoring organization or to members of the fund’s selection committee. Finally, the DAF must also maintain adequate records that demonstrate the need for the assistance provided.
Keep in mind that with respect to charitable organizations, in addition to the requirements outlined in Publication 3833, annual tax or information returns may need to be filed and other requirements may also apply.
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This information is provided as a courtesy, may change and is not intended as legal or tax guidance. Employers with questions or concerns outside the scope of a Payroll Service Provider are encouraged to seek the advice of a qualified CPA, Tax Attorney or Advisor.