On March 13, 2020, President Trump issued an emergency declaration in response to the COVID-19 pandemic. Five days later, on 18 March, the President signed into law the Families First Coronavirus Response Act (H.R. 6201, Families First Act). With these two acts, tax-exempt organizations may now take specific measures to help those directly impacted by the COVID-19 pandemic. Tax-exempt organizations, including private foundations and donor-advised funds, may now make tax-free disaster relief payments under IRC Section 139 without the threat of self-dealing excise taxes or risking exempt status. Additionally, tax-exempt organizations may now create disaster relief funds without designating the funds as a donor-advised funds.

IRC Section 139 and disaster-relief payments

IRC Section 139(a) states "gross income shall not include any amount received by an individual as a qualified disaster relief payment" and applies when, among other factors, the President declares a "disaster" within the meaning of IRC Section 165(i). IRC Section 165(i)(5) defines federally declared disasters to include any disaster determined by the President to warrant federal assistance under the Stafford Act. Accordingly, IRC Section 139 became applicable on March 13, 2020, when President Trump made an emergency determination in response to the COVID-19 pandemic under the Stafford Act.

Under IRC Section 139(d), an employer that provides a qualified disaster relief payment is not required to include those amounts as a component of compensation (or as self-employment earnings) to its employees. The relevant question in light of the COVID-19 pandemic is: what constitutes a "qualified disaster relief payment"? This may include payments to an individual "to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster," provided this amount is not reimbursed by insurance or otherwise. See IRC Section 139(b)(1). The key analysis is whether an expense is "incurred as a result of" the COVID-19 pandemic.

Whether any particular payment is a qualified disaster relief payment will be a factual determination. Under current guidance, voluntarily continuing wages when a retail establishment is closed (by order or otherwise) would not appear to satisfy the statutory standard. Although that fact pattern undoubtedly results in hardships, the standard is whether expenses are incurred as a result of the disaster. In determining whether a payment qualifies as a payment "to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster," organizations should primarily consider whether the expense in question is "new" (either in its need or in its frequency of need) as a result of COVID-19 pandemic.

Qualified disaster relief payments under IRC Section 139 cannot be for expenses that are covered or reimbursed by another source, such as insurance or a grant from a different public charity. Accordingly, as part of their documentation and record keeping, organizations should ask for a signed statement from the recipient employee that these expenses are not being paid for or reimbursed from another source.

Reimbursements by private foundations

The payment of compensation or reimbursement of expenses by a private foundation to a disqualified person generally constitutes an act of self-dealing under IRC Section 4941, which results in excise taxes and possible revocation of tax-exempt status. However, disaster relief payments made under IRC Section 139, including payments from an employer-sponsored private foundation to employees of any related organizations, are not considered taxable income and are therefore excluded from the definition of self-dealing.

IRS Publication 3833 lists the requirements for establishing a presumption that payments made in response to a qualified disaster to employees (or family members of employees) of an employer that is a disqualified person are consistent with the foundation's charitable purpose. These requirements substantially overlap with the requirements for donor-advised funds laid out in Notice 2006-109 and include the following:

• The class of beneficiaries must be large or indefinite (a charitable class).
• The recipients must be selected based on an objective determination of need.
• The selection must be made using either an independent selection committee or adequate substitute procedures to ensure that any benefit to the employer is incidental and tenuous.

Disaster relief funds

One alternative approach for tax-exempt organizations seeking to provide disaster relief is to establish a disaster relief fund. This approach may be particularly relevant to organizations that are not private foundations and for which the activation of IRC Section 139 does not substantially affect their ability to provide disaster relief. The IRS has provided historical guidance on the operation of disaster-relief funds in PLR 200839034 and Notice 2006-109.

PLR 200839034 addressed the criteria and facts necessary to establish a disaster-relief fund when the tax-exempt organization's charitable purposes do not already include specific language covering disaster relief for individuals.

When organizing a disaster relief fund, the IRS noted, the following characteristics were favorable in its determination that the fund's operation would not affect the organization's tax-exempt status:

• The purpose of the disaster relief fund (providing emergency assistance to eligible needy persons who suffer economic hardship due to accident, loss or disaster) was "consistent" with the tax-exempt purposes of the establishing and operating tax-exempt organizations under IRC Section 501(c)(3).
• The fund only provides grants to persons in need based on the objective criteria established in Treas. Reg. Section 1.170A-4A(b)(2)(ii)(D) and those individuals are selected in a nondiscriminatory manner.
• The group of persons eligible for grant assistance, while a smaller subset than the general public, must be sufficiently large and open-ended in its criteria to constitute a charitable class under Treas. Reg. Section 1.501(c)(3)-1(d)(2).
• The disaster-relief fund must keep detailed books and records of the grants provided to recipients, including their name, address, amount provided, purpose for which the aid was given, date and manner of payment, and the relationship (if any) between the recipient and any directors, officers, etc. of the fund or any related organizations.
• The disaster-relief fund is distinguishable from a program designed to offer welfare benefits to employees, as no part of the fund can be used to fund the organization's obligation to pay salaries to employees.

Notice 2006-109 Section 5 excludes certain employer-sponsored disaster-relief funds from the definition of donor-advised fund when the following requirements are met:

1. The fund serves a single identified charitable purpose, which is to provide relief from one or more qualified disasters within the meaning of IRC Section 139(c)(1), (2), or (3).
2. The fund serves a large or indefinite class (a charitable class).
3. Recipients are selected based on objective determinations of need, such as income level, lack of food or shelter, or status affected by a natural disaster or family crisis.
4. The selection of recipients of grants from the fund 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 is independent if a majority of the members of the committee consists of persons who are not in a position to exercise substantial influence over the affairs of the employer.)
5. No payment is made from the fund to or for the benefit of (i) any director, officer or trustee of the sponsoring organization of the fund, or (ii) members of the fund's selection committee.
6. The fund maintains adequate records that demonstrate the recipients' needs for the disaster relief assistance provided.

Implications

The specific measures in this Alert should be weighed in conjunction with provisions discussed in Tax Alert 2020-0586, which highlights additional methods of tax relief for employers and employees as a result of the COVID-19 pandemic.

Tax-exempt organizations should notify the IRS of this additional charitable activity by reporting it on the next-filed Form 990 or Form 990-PF. In addition, these organizations should review their organizing documents (articles of incorporation and by-laws) to confirm that the charitable purpose language contained therein covers disaster-relief payments. If not, an update to include this language may be necessary.

Employer-sponsored private foundations and donor-advised funds should be able to take advantage of the activation of IRC Section 139 and use qualified disaster relief payments as an option to provide tax-free assistance to employees of related organizations that are facing increased financial hardship as a result of COVID-19. The use of private foundations and donor-advised funds as vehicles for these disaster relief payments should be considered particularly when the related employer may be temporarily short on cash reserves. Please note, however, that loans to disqualified persons, even if made to cover disaster-related expenses, may not qualify as IRC Section 139 disaster relief excluded from self-dealing, as the determination is based on individual facts and circumstances. Documentation should be retained to support conclusions made.

An alternative approach for tax-exempt organizations to provide disaster relief to affected employees is to create a disaster-relief fund. These funds are less onerous to establish than new private foundations or public charities and, if structured and operated properly, can be used to avoid potential excise tax on payments to individuals. Organizations seeking to establish these funds should closely follow the guidance provided in Notice 2006-109 and must meet each of six requirements to maximize the amount of funds available for disbursement.

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