Press Room: Tax Release
Tax-Effective Ways to Provide Assistance to Individuals During the COVID-19 Pandemic
There are a number of ways individuals and businesses can help individuals in their communities and affected employees during a time of crisis, including charitable-based programs, direct financial assistance to employees, employee loans, and paid family and medical leave. Each option has different restrictions in terms of recipients, types of payments that may be made, and the documentation and coordination required. In addition, through various provisions of the CARES Act, individuals and businesses can help with highly tax-efficient direct charitable giving. Below we highlight several options for assistance to affected individuals in the context of the COVID-19 pandemic and the general requirements and tax benefits of each approach.
Charitable-Based Programs – Private Foundations and Public Charities
Three requirements apply to the charitable-based programs discussed below:
- The class of potential beneficiaries should be large or indefinite;
- The recipients should be selected based on an objective determination of need and documentation must be maintained to support this finding; and
- The recipients should be selected by an independent selection committee or adequate substitute procedures must be in place to ensure that any benefit to the employer is incidental.
Private Foundations
Many private foundations have been approved only to make gifts to public charities. However, private foundations can make payments to individuals in the community, employees of a business or their family members affected by disasters or in emergency hardship situations. The three requirements above also need to be met. If you do not already have a foundation, the process to establish a private foundation is swift, and can generally be accomplished within a few days. A business could also set up an employer sponsored private foundation.
An existing foundation would not need to seek prior approval from IRS to make direct grants, although if not otherwise covered in the description of its purposes, the organization would need to disclose this program in its next annual filing with IRS. If a new private foundation is established to provide financial assistance to individuals who suffer a financial hardship as a result of the COVID-19 pandemic, it will need to continue beyond the current disaster for other charitable purposes or to aid individuals with other financial emergencies.
Public Charities
Public charities can provide all the same relief as private foundations as outlined above. However, based on relative size and infrastructure, public charities may be better situated than private foundations to provide assistance, particularly in the area of fundraising. For reasons set forth below, contributions directly to these support organizations could be less tax efficient for donors, particularly those making very large contributions. Therefore, donors making donations to public charities with support organizations should make clear that donations should go to the public charity entity directly and not through the support organization in order to take advantage of the suspended AGI limitation in 2020 (see below). For most purposes, a private foundation that is an operating foundation is also treated as a public charity.
A business can establish an employer-sponsored public charity that provides aid in any type of disaster or employee hardship situation, so long as the related employer does not exercise excessive control over the charity. Generally, employees contribute to the public charity and rank and file employees constitute a significant portion of the board of directors.
In order to qualify as a public charity, the charity must receive donations from a sufficiently broad number of donors (with a test defined by statute) and then the organization could provide financial assistance to any employee who experiences a family hardship as a result of COVID-19.
Proper procedures are important but if followed correctly, any financial assistance provided by a public or private charity should not be taxable to the recipient employee. The public charity itself is also exempt from federal income taxation and a private foundation has a small excise tax on net income.
Donor-Advised Funds (DAFs)
Some community foundations and public charities maintain separate funds or accounts to receive contributions from individual donors. Donors receive advisory privileges over investment or distribution of the donated funds. While DAFs generally may not make grants to individuals, an exception is made for funds or accounts established specifically to benefit a business’s employees and their family members who are victims of a qualified disaster, such as the COVID-19 pandemic.
In order for an employer-sponsored DAF to be able to give directly to employees, the fund must meet the three requirements set forth above and no payment may be made from the fund to or for the benefit of any director, officer, or trustee of the sponsoring community foundation or public charity, or any person who is selecting recipients.
Employer Assistance to Employees
Section 139 allows a business to provide tax-free payments to its employees if the payments are qualified disaster relief payments. A qualified disaster includes a presidential-declared disaster, such as the COVID-19 pandemic. A qualified disaster relief payment is any amount paid to or for the benefit of an individual and includes payments to employees to reimburse or pay for reasonable and necessary personal, family, living or funeral expenses incurred as a result of a qualified disaster. An employer that chooses to provide qualified disaster relief payments should have a plan that is communicated to employees detailing expenses entitled to reimbursement, a process for validating the expenses meet the Sec. 139 requirements, and how to get reimbursement.
Qualified disaster relief payments are not included in the income of recipients to the extent that any expenses covered by these payments are not otherwise compensated by insurance or other reimbursement. Qualifying payments are not subject to income tax, self-employment tax, or employment taxes even if the payments are made directly from the employer. Such payments are deductible to the business under Sec. 162 as a trade or business expense.
Employers may make interest-free loans to their employees, up to $10,000 per employee. If over $10,000, interest must be imputed of at least the Applicable Federal Rate (AFR). As with any fringe benefit, the employer should have clear policies and procedures that detail the loan program including circumstances of the loan, loan amount, loan term, and repayment method. If the loan is forgiven, the employee would have taxable income and the employer would have a Sec. 162 deduction for compensation.
An advantage of providing direct assistance to an employee from the employer is that a showing of financial need is not required from the employee, unlike with payments from a charity.
Deductibility of Charitable Contributions
There are certain limitations on deductions for making charitable contributions. These limitations are largely based on the amount of income earned by an individual or corporation in a given year. Under the CARES Act, some of these limitations are relaxed for contributions made in the calendar year 2020.
Prior to the CARES act, the deduction for individuals making cash contributions to public charities was limited to 60% of their adjusted gross income (AGI). There are different limitations for non-cash contributions and contributions to private foundations. Under the CARES Act, at the election of the taxpayer, that limitation is increased to 100% of AGI for qualified contributions. In other words, there is no limitation. A qualified charitable contribution is defined as a cash contribution made to a public charity other than donor-advised funds and Sec. 503(a)(3) support organizations. Additionally, private operating foundations are eligible for the 100% AGI limit, while gifts to non-operating foundations are not.
At the election of the taxpayer, the CARES Act increases the limitation from 10% to 25% of taxable income for qualified contributions made by a C corporation. Qualified contributions are defined the same way as for individual taxpayers.
The CARES Act also increases the deduction for contributions of food inventory from 15% to 25% of taxable income. Food inventory contributions must be of wholesome food, as defined in Public Health and Welfare Law Sec. 1792(b)(2), and be intended to benefit the sick, needy or children.
The Takeaway
A qualified disaster like the COVID-19 pandemic opens the door to a wide range of options for individuals and businesses who want to provide community assistance. By utilizing one of the approaches described above, an individual or business may instead be able to provide tax-free support to those who are affected by COVID-19, while also preserving the ability to deduct the payments of financial assistance as a charitable donation or a trade or business expense. Your Andersen advisor can assist you in selecting and implementing an appropriate assistance strategy depending on your goals and tax position.
About the Authors
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Joseph P. Toce, Jr.Greenwich,, CT
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Carl C. FioreNew York, NY
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Dennis A. MinichChicago, IL
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Mary DuffyWashington, D.C.