X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
The devastation of New Orleans and the Gulf Coast by Hurricanes Katrina and Rita has elicited generous support from charitable donors nationwide as well as from employers seeking to aid their employees and their families in the disaster area. Congress, too, has acted swiftly to assist hurricane victims. The Katrina Emergency Tax Relief Act of 2005 was introduced almost immediately after Hurricane Katrina made landfall on Aug. 29, and was signed into law by the president on Sept. 23. As the outpouring of financial support to the region reaches unprecedented levels, companies, charitable contributors, and charitable organizations will have to consider the issue of federal income taxes on various kinds of disaster-relief payments. As with any tax matter, it is important to understand the issues involved and to make all necessary preparations sooner rather than later. PAYMENTS TO AFFECTED EMPLOYEES Financial support a company provides to its employees and their families in the disaster area (using either the company’s own funds or donations from other employees) can generally be excluded from the recipients’ income. The primary basis for this is a new Internal Revenue Code provision, Section 139, enacted after Sept. 11, 2001, specifically to address situations like the one the country is facing now. Section 139 has been a little-known part of tax law, but Katrina and Rita have brought it to the forefront. This section allows recipients of “qualified disaster relief payments” to exclude all those payments from their income. Qualified disaster-relief payments, provided after any presidentially declared disaster (such as the recent hurricanes) or any military or terrorist attack, include payments to any individual for personal, family, living, or funeral expenses incurred as a result of the disaster; costs to repair or replace a personal residence or its contents for damage caused by the disaster; and all aid or relief payments provided by governmental agencies in the wake of the disaster. Thus, under Section 139 almost all payments to support individuals and their families after the hurricanes will be excluded from the recipients’ income for income-tax and employment-tax purposes. The tax exclusion is allowed, however, only to the extent that such expenses are not otherwise reimbursed through insurance or other sources. If recipients receive insurance or other reimbursement later for expenses for which they’ve already received direct aid, they’ll have to pay tax on the later reimbursements. The Internal Revenue Service Web page newsroom has more disaster-relief tax information and other information. On the deduction side, many tax professionals are advising companies that disaster-relief payments they make to their employees from company funds are deductible as ordinary and necessary business expenses even though the payments are not treated as “compensation” to the recipients. While there are reasonable arguments for this, the issue remains somewhat unsettled. The IRS has not given specific guidance on whether companies can deduct such payments. Although the IRS has been asked to clarify this question, the agency hasn’t provided specific answers yet; thus, companies do face some risk if they deduct relief payments made to affected employees and their families. On balance, though, there are reasons to believe that companies will be able to deduct relief payments. Employees making cash payments to their employers so that the employers may send those funds to co-workers in the disaster area cannot deduct their payments. Individuals donating money or other property for disaster relief can take charitable-contribution deductions only if the contributions are made to recognized 501(c)(3) charitable organizations. But the IRS has specifically announced that employees may donate unused vacation, sick leave, and personal time to their employers, who may then donate such amounts in cash to charitable organizations providing disaster relief � all without the employees having to recognize any income. If a company sets up a program to allow this, employees can donate their vacation, sick leave, and personal time and can deduct this from their taxes. Contributions made by individuals and companies to recognized charitable organizations engaged in disaster-relief activities, such as the Red Cross, as well as to governmental organizations assisting disaster victims, are deductible as charitable contributions. Recipients of such assistance � whether it is in the form of cash payments or in-kind support such as housing, clothes, and food � do not have to pay tax on the amounts received. Another issue that the IRS has been asked to clarify is whether private foundations, including company-sponsored foundations, may make disaster-relief payments to hurricane victims without receiving a special ruling beforehand from the IRS. Private foundations and company foundations are specialized types of charities that are subject to tighter regulation than public charities such as the Red Cross and the Salvation Army. Without question, foundations may make grants and contributions to the Red Cross and other public charities to support hurricane-relief activities. Tax questions arise only if foundations make relief payments directly to individual recipients. Advance approval from the IRS may be required when a private or company foundation makes grants to specific people or groups of people, such as individual hurricane victims, or when a company-sponsored foundation provides support to the company’s employees or their families. This is an ongoing question that the IRS has not yet given specific guidance on. Though it remains uncertain, what is hoped (and expected) is that the IRS will be generous in allowing private and company foundations to support hurricane victims without unreasonable scrutiny or second-guessing. Company foundations in particular should confer with their tax advisers about their hurricane-relief efforts. HURRICANE-RELIEF TAX BILL Congress moved immediately after Katrina to provide tax relief to hurricane victims, and to clarify some of the tax questions that have arisen about disaster relief. The Katrina Emergency Tax Relief Act of 2005 included the following provisions: • Individuals in the Hurricane Katrina disaster area who have suffered an economic loss as a result of the storm may withdraw up to $100,000 from their qualified retirement accounts, including IRAs, without penalty. People who make such withdrawals may redeposit those amounts into their retirement accounts any time during the next three years without penalty. • Small businesses (up to 200 employees) in the Katrina disaster area are granted an “employee retention tax credit” equal to 40 percent of the first $6,000 of wages paid to each employee during the period the business remains closed because of the storm. • For charitable contributions made to recognized public charities and governmental entities between Aug. 28 and Dec. 31, 2005, the percentage-of-income limitations are suspended. That is, both individuals and corporations may take deductions for those contributions up to 100 percent of their income, instead of the usual 50-percent-of-income limitation imposed on individuals and 10-percent-of-income limitation imposed on corporations for charitable-contribution deductions. Corporate contributions must be specifically directed to Hurricane Katrina relief efforts to qualify for the no-limitation rule, but there is no such restriction for charitable contributions made by individuals between Aug. 28 and Dec. 31. Contributions to private foundations and to so-called donor-advised funds do not qualify for the no-limitation rule. An important point to note is that, despite some early news reports, Congress did not pass a suggested provision that would have allowed tax-free rollovers of IRA funds directly to charitable organizations for hurricane relief. Instead, the IRA tax relief in the bill is limited to withdrawals for personal support. Nevertheless, the suspension of the 50-percent-of-income limitation on charitable contributions for the remainder of 2005 does allow individuals who are above the age of 59 and a half (and therefore can make penalty-free IRA withdrawals) to withdraw funds from IRAs and donate the money to charity at relatively low tax cost. These “indirect” charitable rollovers are an intriguing opportunity for interested donors, but structuring these contributions may be complex. Donors should consult their tax professionals about this opportunity. QUESTIONS REMAIN The outpouring of support for the victims of the unprecedented disaster caused by Hurricanes Katrina and Rita has raised many tax questions for donors, employers, and aid recipients. Generally, recipients of aid in the disaster regions should be able to exclude from income almost all relief payments they receive from employers and from charitable relief organizations. Also, contributions to recognized charitable organizations to assist in disaster relief are tax-deductible. Uncertainties remain, however, about companies’ deductions for disaster relief paid directly to victims, and about relief payments made to individuals by company-sponsored charitable foundations and other private foundations. While unanswered tax questions remain, it is important that companies and individuals confer with professionals. Only then can they acquire a full understanding of the tax complexities of their generosity.
Richard Riley is a tax partner in the Washington, D.C., office of Foley & Lardner.

This content has been archived. It is available through our partners, LexisNexis® and Bloomberg Law.

To view this content, please continue to their sites.

Not a Lexis Advance® Subscriber?
Subscribe Now

Not a Bloomberg Law Subscriber?
Subscribe Now

Why am I seeing this?

LexisNexis® and Bloomberg Law are third party online distributors of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® and Bloomberg Law customers are able to access and use ALM's content, including content from the National Law Journal, The American Lawyer, Legaltech News, The New York Law Journal, and Corporate Counsel, as well as other sources of legal information.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2021 ALM Media Properties, LLC. All Rights Reserved.