Over the last two weeks, wildfires have caused significant damage and destruction to homes and communities in Los Angeles, California, and the surrounding areas. In the aftermath of this devastation, employers may look for ways to offer financial support to employees affected by the disaster. Thankfully, the Internal Revenue Service (IRS) has provided guidance on how employers can assist employees impacted by natural disasters like the wildfires, through options such as tax-free qualified disaster relief payments, leave donation programs, and other tax-efficient measures.
Qualified Disaster Relief Payments – Typically, payments made by an employer to an employee must be included in the employee’s taxable income unless a specific exception applies. One such exception is for “qualified disaster relief payments” under Section 139 of the Internal Revenue Code. Employers can provide these payments to employees affected by disasters like the Los Angeles wildfires, free from taxes.
These qualified disaster relief payments can take the form of reimbursements or cash advances, and they are not subject to payroll taxes (e.g., Social Security and unemployment taxes). Furthermore, employers can treat these payments as ordinary and necessary business expenses, allowing them to be deducted from the employer’s taxes.
For a payment to qualify as a “qualified disaster relief payment,” the following criteria must be met:
- There must be a “qualified disaster” (for example, a federally declared disaster as designated by the President of the United States).
- The payment should cover reasonable and necessary expenses, such as personal, family, living, or funeral expenses, or costs associated with repairing or replacing a personal home or its contents, as long as these expenses were incurred due to the disaster and are not covered by insurance or other resources.
- The payment must not be intended to replace lost income (e.g., lost wages, business income, or unemployment benefits).
Employers do not need a formal written plan to make these payments. However, it’s advisable for employers to establish a process to ensure compliance with the legal requirements. A simple application form could be used to confirm that the employee’s request for relief is tied to the wildfires, that the funds are necessary, and that insurance will not cover the expenses.
Employees are not required to submit detailed expense records, as long as the amount of the payment is reasonable in relation to the expenses incurred. While formal substantiation is not mandatory, it is recommended that employers ask employees to provide an attestation statement confirming their eligibility for the tax-free relief.
Leave Donation Programs – Because the wildfires have been federally declared a disaster, employers can establish “leave banks,” allowing employees to donate accrued but unused leave to colleagues who have been affected. Employees who donate leave do not have to pay taxes on the donated amounts. However, employees receiving donated leave will be subject to payroll and income taxes on the leave they receive.
Employer-sponsored leave donation programs must be written and meet the requirements outlined in IRS Notice 2006-59 to ensure favorable tax treatment for both the donors and recipients.
Retirement Plan Options – Employer-sponsored defined contribution retirement plans can also offer relief to “qualified individuals” affected by a qualified disaster. A “qualified individual” is someone whose primary residence is in the disaster area during the incident period and who has experienced an economic loss due to the disaster. The following options are available through employer-provided retirement plans:
- Distributions of up to $22,000 from the plan without incurring the usual early withdrawal penalty. These distributions must be taken within 180 days of the disaster declaration.
- Increased loan limits, allowing up to 100% of a participant’s account balance, up to $100,000.
- An extended loan repayment period of one year for any outstanding loans as of the disaster declaration date. This extension allows repayment until January 8, 2026.
Employers may need to amend their retirement plans to include these disaster-related provisions, and such amendments must be made by the end of the current year in order for employees to take advantage of these options.
Conclusion – Our DC employment lawyers know there are employers who wish to offer financial assistance to employees impacted by the recent wildfires should consider the various tax-advantaged programs available through the IRS. Given the different requirements for each program, employers must ensure that these programs are properly structured to meet the necessary legal standards.