The devastation of New Orleans and the Gulf Coast by Hurricane Katrina, then Hurricane Rita, has elicited generous support for the victims 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.
This report explains the federal income tax treatment of the different kinds of disaster relief payments that are currently being made by employers, charitable contributors, and charitable organizations.
Payments Made by Companies and Co-workers to Affected Employees
Financial support provided by a company to its employees and their families in the disaster area (using either the company’s own funds, or funds of employees that the company may collect and distribute for this purpose) can generally be excluded from the recipients. income. This is because the payments may be treated as nontaxable .gifts. to the recipients, and also because of a new Internal Revenue Code provision, section 139, that was enacted after September 11, 2001 specifically to exclude various kinds of disaster relief payments from income tax. As the IRS web page on Katrina-related tax issues states:
.People in a Presidentially-declared disaster area who receive grants from state programs, charitable organizations or employers to cover medical, transportation or temporary housing expenses do not include these grants in their income..
(From: www.irs.ustreas.gov/newsroom/article/0%2C%2Cid=147240%2C00.html)
Many tax professionals are advising companies that disaster relief payments made 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 in favor of deductibility, it should be noted that this issue remains somewhat unsettled, and the IRS has not given specific guidance on whether such payments are deductible by the companies that make them. The American Bar Association Section of Taxation has asked the IRS to clarify this deduction question.
Cash payments made by individual employees to their employers, so that the employers may send those funds to co-workers in the disaster area, are not deductible by the employees making the 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.
However, the IRS has announced that employees may donate unused vacation, sick leave, and personal time to their employers, and the employers 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/personal time with no negative tax consequences.
Payments Made through Charities and Charitable Foundations
Contributions made by individuals and companies to recognized 501(c)(3) charitable organizations engaged in disaster relief activities, such as the Red Cross and many other organizations, as well as to governmental organizations assisting disaster victims, are deductible as charitable contributions. In addition, for the reasons noted above, recipients of such assistance, whether 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.
One 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 which are subject to tighter regulation than public charities such as the Red Cross, Salvation Army, etc. Advance approval from the IRS may be required when a private foundation 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 employees. families.
It is hoped (and expected) that the IRS will be generous in allowing private foundations and company foundations to support Hurricane Katrina and Hurricane Rita victims without unreasonable scrutiny or second-guessing, but this remains uncertain. Company foundations, in particular, should confer with their tax advisors about any hurricane relief efforts in which they are involved.
Hurricane Relief Tax Bill Passed by Congress
In mid-September, Congress passed and the President signed into law the .Katrina Emergency Tax Relief Act of 2005.. Important provisions include the following:
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 IRA.s, without penalty. People who make such withdrawals may redeposit the withdrawn amounts into their retirement account 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% 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 during the period August 28, 2005 through December 31, 2005, the percentage-of-income limitations are suspended. That is, both individuals and corporations may take deductions for those contributions up to 100% of their income, instead of the usual 50%-of-income limitation imposed on individuals and 10%-of-income limitation imposed on corporations for charitable contribution deductions. Corporate contributions must be specifically directed to Hurricane Katrina relief efforts in order to qualify for the no-limitation rule, but there is no such restriction for charitable contributions made by individuals during August 28, 2005 through December 31, 2005. Contributions to private foundations, and to so-called donor-advised funds, do not qualify for the no-limitation rule.
Please get in touch with any member of the Foley & Lardner LLP tax department, or your usual Foley contact, if you have any tax questions about hurricane relief efforts.
*Richard Riley is a tax partner in the Washington, D.C. office of Foley & Lardner LLP.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
