How Tax Code Section 139 Can Save You HUGE Taxes
If tax advice sounds too good to be true, then it probably is. But today we’d like to introduce you to the unicorn of the tax world: Section 139. It can save both you and your employees huge on taxes; it can put additional tax-free money in your and your employees’ pockets; it requires very little documentation in terms of receipts and other backup documents; and it’s completely real. So really, that makes it better than a unicorn.
Section 139 (26 USC §139) is a little-known and little-used provision of the tax code addressing disaster relief. At least, it was little-used until COVID hit. Then, on March 13, 2020, President Trump declared COVID a national emergency, which unlocked Section 139 for businesses across the nation.
In short, Section 139 says that “qualified disaster relief payments” do not count toward an individual’s gross income. In other words, these payments are not taxable. So, if an employer provides “qualified disaster relief payments” to an employee, the employee does not have to pay taxes on that money.
Why Section 139 Is Significant for Employers (Especially Small Business)
At first glance, it sounds like Section 139 is only good for employees, who can receive certain payments from their employers tax-free. But there are at least two potentially significant benefits to the employers.
First, even though the employee isn’t taxed on the payment, the employer still gets to deduct the payment as a business expense. So, an employer looking to increase its expenses and reduce taxable income can benefit by providing its employees with qualifying payments.
Second, companies can make these qualifying payments not only to employees, but also to business owners. That means that a business owner can make qualifying payments to herself; she can deduct the expense of that payment as a business expense; and not have to report the receipt of that payment as taxable income. In other words, she can basically take a tax-free draw from the business. Assuming a 30% marginal tax rate, an owner who reimburses herself $10,000 in qualifying payments saves $3,000 in taxes by doing so.
What Reimbursements Qualify For Section 139 Treatment?
While Section 139 is broad, and the requirements are somewhat less formal than the requirements for other tax breaks, Section 139 reimbursements must be:
- Reasonable. Reimbursing an employee $1000 for a COVID test, or $500/day/person for food, is probably not reasonable.
- Necessary. Luxury or decorative items likely wouldn’t be necessary. And, even though it feels like that Netflix subscription probably was necessary to survive COVID, the IRS would probably disagree.
- Reimbursement for personal, living, family, or funeral expenses. For example, wages and commissions are not reimbursements to the employee, so they do not qualify.
- For expenses resulting from the disaster. Although this requirement is quite broad, not all expenses result from COVID. For example, the expense of a new gym membership, when most gyms were closed due to COVID, may not result from COVID.
If a reimbursement does not meet all of the above criteria, then it is not a “qualifying payment.”
What Are Some Examples of Section 139 Payments?
Section 139 can cover a broad range of payments. Qualifying payments may include:
- Increased costs of childcare or tutoring due to school closings
- COVID-related over-the-counter medications, hand sanitizers, and disinfectant supplies
- Work from home expenses, including supplies and utilities
- Increased costs of food due to at-home kids and college students
- Extra costs for grocery delivery
- Temporary housing or other quarantine costs
- Critical care or funeral expenses resulting from COVID
- Costs of food or toilet paper reserves
What Payments Don’t Qualify Under Section 139?
Although Section 139 is pretty broad, it’s important to know what payments do not qualify under Section 139. The following list is not exhaustive, but non-qualifying payments may include:
- Anything reimbursed to the employee/owner by any insurance. This includes items covered by a health insurance plan, even if the health insurance does not reimburse for that particular expense (such as copays).
- Anything reimbursed to the employee/owner under any other accounting plan (such as regular stipends or reimbursements for home offices, work from home days, cell phones, and the like).
- Anything reimbursed “otherwise.” This might include disaster relief the employee/owner received as reimbursement for the same expenses from another employer, a local nonprofit, or other organization (including government reimbursements and funds). In other words, there’s no “double-dipping,” that is, receiving reimbursement for the same expenses twice.
- Anything replacing lost income, such as sick or vacation leave.
What Deadlines Apply?
There are a few time periods employers need to track to make qualified reimbursements to employees and owners.
- In the case of COVID, President Trump declared the “qualifying disaster” – that is, the disaster began – on March 13, 2020.
- President Biden extended the disaster until “beyond” March 1, 2021.
- So, unless the President or Congress terminates the disaster declaration sooner, or extends it again early next year, then President Biden’s declaration will remain in effect through March 12, 2022. (See 50. U.S.C. §1622(d))
- This means that Section 139 payments cover reimbursements for expenses incurred from March 13, 2020 through March 12, 2022 or until canceled, whichever is first.
What Documentation Requirements Apply?
This is one of the most surprising things about Section 139. While the IRS typically requires mountains of receipts and backup documentation for deductible business expenses, Section 139 generally dispenses with the requirement for backup documents like receipts and invoices. Which makes sense, because in many disaster situations, that backup documentation would have been destroyed.
Also, unlike retirement and other accounting plans, Section 139 does not require formal written plans. That said, we strongly recommend putting one together for your business anyway. Having a written plan will help to communicate the plan to employees and help them take advantage of its benefits; reduce the chances of employee fraud in the reimbursement process; ensure the plan is applied equitably (although, unlike retirement plans, Section 139 does not require complete equity or checks for owner over-compensation, so long as the distributions are reasonable); put caps on amounts reimbursed to various classes of employees; and provide a method for employees to support their requests for reimbursement with sworn statements to help back up the “reasonable” and “necessary” nature of the expenses.
What Does A Section 139 Plan Look Like?
We’ve put together a sample Section 139 plan to help you get started. As with all legal documents, it’s just that – a sample, not a one-size-fits-all – and it’s important to modify the sample to fit your business. The attorneys at Skepsis Legal are ready to help, so once you click the link below to download your sample plan, be sure to book a consult with us to further develop your plan and make it right for you and your company.
DOWNLOAD YOUR SAMPLE 139 PLAN HERE.