Hurricane Harvey and the devastation that it has caused in Texas and Louisiana are very much on the minds of employers that want to provide assistance to their employees who live and work in the affected area. The Federal Emergency Management Agency (FEMA) has declared portions of Texas to be a major disaster area and portions of Louisiana to be an area for emergency relief. Many employers are establishing arrangements to collect funds to provide financial assistance to their employees who reside in the area affected by the storm.

This Alert addresses the federal income tax rules that apply when an employer establishes an arrangement, other than a tax-exempt entity, to collect after-tax contributions from its employees and make distributions to employees who reside in the federally declared Hurricane Harvey disaster zones (affected employees).

As discussed in an earlier Alert, employers may also establish arrangements, such as a tax-exempt foundation, public charity or a donor advised fund, to collect tax-deductible contributions from their employees. (See Tax Alert 2017-1398) These types of tax-exempt arrangements permit employees to make contributions on a tax-deductible basis, but can be more complicated and time-consuming to establish.

Background

Employers have established "funds" in the employer's name to collect contributions from employees on an after-tax basis. For example, employers have established a separate bank account or another similar arrangement, for example, through PayPal, a platform such as GoFundMe, or a similar arrangement. The employer is the legal owner of the assets contributed to the fund and has the right to direct who will receive payments from the fund and how the distributions will be made.

Frequently asked questions

How are contributions to the fund taxed? Contributions to the fund established by an employer and any earnings on the contributions are income to the employer who is the legal owner of the fund and controls the distributions. (The employer, however, is entitled to a corresponding tax deduction, as discussed later.) Because the employer controls the distribution of the fund for the benefit of its own employees, the employer likely is not treated as a mere "conduit" for federal income tax purposes.

Do employees who contribute to the fund receive a federal income tax deduction? No.

Does the employer receive a tax deduction when payments are made to affected employees? Yes. Payments made by employers to affected employees, including payments made out of a fund described in this fact pattern, are compensatory and, therefore, deductible to the employer under Section 162 in the tax year that the payments are made out of the fund.

Are employer payments from the fund taxable income or wages to affected employees? No. Section 139 provides that these amounts paid to victims of the hurricane in the qualified disaster areas are excludible from income because they are considered "qualified disaster payments" and not treated as wages if the distributions are reasonably designed to provide funds that do not exceed the affected employee's unreimbursed expenses. (See Tax Alert 2017-1392)

Must the employer receive documentation or receipts for expenses from affected employees before making an immediate distribution? Generally, no. Under IRS Section 139, if the distribution is in an amount that is reasonable to believe will not exceed the affected employee's unreimbursed expenses as a result of the storm, IRS guidance provides that no specific documentation is required. An employer generally may rely upon affected employee's representations as to unreimbursed expenses.

Implications

As noted, many employers are seeking a way to efficiently collect funds for the benefit of employees who are victims of Hurricane Harvey in the designated qualified disaster areas. Some employers have decided not to set up a separate charitable organization or to use an existing charity to handle these funds. Employers can accomplish the same goal by establishing a fund to collect contributions from employees and provide payments from the fund directly to the affected employees in a manner that satisfies Section 139. In this case, the relief payments made from the fund to affected employees are not included in the employees' income, but employee contributions to the fund are not tax-deductible.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.

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