Tax-Free Employee Bonuses

In this world there are few times where you can have your cake and eat it too. Is there a way you could give your employees a bonus that you get to deduct and they don’t have to claim as income? The answer to that is almost always “no” but this year, there might be a way.

COVID-19 and the president’s earlier declaration of a federal disaster for the states and territories of the United States of America invoked Section 139 of the Internal Revenue Code and the ability of an employer to make qualified disaster relief payments. Under the code, an employer can make relief payments to their employees that are both deductible to the employer and non-taxable to the employee. Most commonly, we see these declarations and payments made during the time of natural disasters, but the pandemic by way of the President’s declaration also qualifies.

Granted, an employer just can’t write a bonus check and call it a relief payment. The employer must do some due diligence about what qualifies as a qualified employer provided relief payment in order to provide tax-free funds to impacted employees. These relief payments do not have to be the same for each employee (but may be) nor do they have to be given to every employee. In other words, the employer has the discretion to help an employee that has been impacted more by the disaster than another by giving more to that employee.

A qualified disaster relief payment is for the following purposes:

• Reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster. (Think of what the pandemic has changed – masks, sanitizer, increased utilities from working and schooling from home, additional technology and office supplies to allow kids to participate in online studies or for an employee to be able to work from home, medical testing, quarantine expenses if exposed, mental health professionals assisting with the anxiety and stress of the pandemic’s impact, and other related medical costs if positive.)
• Reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replace its contents to the extent that the need for such is attributable to a qualified disaster. (As the pandemic has not destroyed physical property, this purpose may not apply. It is possible if creating a required home office necessitated rehabilitation of the property that this purpose may apply.)
• Payments by reason of death or personal physical injuries incurred as the result of qualified disaster by someone engaged in the furnishing or sale of transportation as a common carrier. (This purpose doesn’t apply for most of the population.)

A key here is that the payments made are reasonable in nature and for necessary expenses. They also cannot be for something that has already been accounted for by insurance or other means. (For example, if your health insurance plan covered testing of your employees, you couldn’t include the cost of the testing in your relief payment.)

The payments do not have to have significant documentation. In addition, proof of these expenses does not have to be provided by the employee.

Personally, I have seen money spent on protective gear, cleaning supplies and sanitizers as a result of the pandemic that I would not have normally spent. I have seen my home utilities increase as work and school from home happened. I have seen family members need to be tested and quarantine while awaiting results from possible exposure or symptoms and miss work. I have seen counseling visits and other therapy to help with the stress and anxiety that have come from the pandemic. All of these costs would not have been incurred absent the pandemic.

It is my belief that as long as the amounts are reasonable and for necessary expenses related to the pandemic and the purpose of the payment is documented, an employer can make pandemic related qualified relief payments to their employees for these and perhaps other expenses.
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While not technically a bonus, providing a qualified relief payment to employees at this time of year provides a great tax deduction to the employer and tax-free money to impacted employees.