Over the past two weeks, wildfires have caused substantial loss and damage to homes and communities in Los Angeles, California, and the surrounding areas. In the wake of such devastation, employers may seek opportunities to provide financial assistance to impacted employees. Fortunately, the Internal Revenue Service (IRS) has outlined various ways for employers to provide much-needed assistance to employees impacted by natural disasters like the wildfires, including tax-free qualified disaster relief payments, leave donation programs, and other tax-efficient options.

In Depth

QUALIFIED DISASTER RELIEF PAYMENTS

Generally, payments made by an employer to, or for the benefit of, an employee must be included in the employee’s taxable gross income unless excluded under another provision. One such exclusion is “qualified disaster relief payments” under Section 139 of the Internal Revenue Code. Employers can make “qualified disaster relief payments” to employees who are victims of many disasters, including the Los Angeles wildfires, on a tax-free basis.

Qualified disaster relief payments include both reimbursements and cash advances and are not treated as taxable income/wages subject to payroll taxes (e.g., Federal Insurance Contributions Act and Federal Unemployment Tax Act) for employees. In addition, employers can deduct these payments as ordinary and necessary business expenses.

A payment qualifies as a “qualified disaster relief payment” if the following requirements are satisfied:

• There has been a “qualified disaster” (e.g., a federally declared disaster issued by the president of the United States).
• The payment is intended to cover reasonable and necessary personal, family, living, or funeral expenses, or reasonable and necessary expenses incurred for repairing or replacing a personal residence or its contents, provided the expenses were incurred as a result of the qualified disaster and are not covered by insurance or other resources.
• The payment is not income replacement (i.e., a payment for lost wages, lost business income, or unemployment benefits).

Qualified disaster relief payments do not need to be paid pursuant to a plan document. In fact, a formal written plan document is not required or recommended. Nevertheless, given the benefits of tax-free status for qualified disaster relief payments, employers that choose to provide such payments should consider adopting an administrative process to validate such payments meet the necessary legal requirements. Such a process can include a short application form for assistance that validates the disaster for which relief is sought, contains an affirmative statement from the employee that the requested funds are necessary for expenses associated with the Los Angeles wildfires, and confirms that such expenses are not reimbursable by insurance.

In addition, employees are not required to account for actual expenses in order to qualify for the exclusion, provided that the amount of the payments can be reasonably expected to be commensurate with the expenses incurred. Although substantiation is not required, a simple application/attestation statement from the employee is recommended to provide the employer with assurance regarding its compliance with the legal requirements for offering these payments on a tax-free basis.

LEAVE DONATION PROGRAMS

Since the wildfires have been federally declared a natural disaster, an employer may establish “leave banks” for employees to donate accrued but unused leave to other employees who may be affected by the wildfires. Employees who donate their accrued leave are exempt from taxes on those amounts, but those who receive the leave will incur payroll and income taxes for the time given. Employer-sponsored leave banks programs must be written and must meet certain requirements under IRS Notice 2006-59 to receive favorable tax treatment for both the donor and recipient employee.

RETIREMENT PLAN OPTIONS

An employer-sponsored defined contribution retirement plan can provide additional relief to “qualified individuals” impacted by a qualified disaster. A “qualified individual” is an individual whose principal residence during the incident period of any qualified disaster is in the qualified disaster area and the individual has sustained an economic loss by reason of that qualified disaster. Employer-provided retirement plans can provide the following options:

• Distributions up to $22,000 per federally declared disaster, with no early withdrawal penalty. Such distributions must be taken within 180 days of the date the disaster was declared.
• Increased maximum loan amounts equal to 100% of a participant’s account balance, up to $100,000.
• Extended repayment period of one year for current outstanding loans (as of date such natural disaster was declared). In this case, employers can extend repayment of loans to January 8, 2026.

Employers will need to amend their retirement plans if their plans do not already have such disaster-related provisions. Such amendments must be made by the end of this year for employees to take advantage of these provisions.

SUMMARY

Employers seeking to provide financial assistance to employees should consider the various tax-advantaged programs made available by the IRS. Since the requirements of each program vary, it is important that employers properly structure these programs to comply with the necessary legal requirements.