- Bulletin 02-05, Victims of Terrorism Tax Act Encourages Disaster Relief By Employers and Charities
- April 30, 2003
- Law Firm: Pillsbury Winthrop LLP - Office
On January 23, 2002, President George W. Bush signed into law the Victims of Terrorism Tax Relief Act of 2001 (the Act), P.L. 107-134, providing sweeping tax relief in a variety of forms to aid terrorism victims and their families. This Bulletin focuses on the provisions of the Act that enhance the ability of employers and charities to provide disaster relief.
Qualifying Disaster Relief Payments Exempt From Income Tax
The Act establishes new section 139 of the Internal Revenue Code (the Code), effective for tax years ending on or after September 11, 2001. That section provides that qualifying payments from any source, including employers, reimbursing individuals for specified disaster-related expenses are not taxable as income and are not subject to employment taxes or withholding. Nonetheless, such payments remain deductible to the payor to the extent they would have been deductible were the payments not exempted from tax.
To qualify, payments must meet two requirements. First, they must be made to an individual in connection with "qualified disasters," including those resulting from terrorist or military action or those declared catastrophic by the President or the Secretary of the Treasury. Second, they must be made for personal, family, living, or funeral expenses resulting from the disaster and/or for the repair or rehabilitation of a personal residence or its contents attributable to the disaster. Payments do not qualify, however, to the extent the recipient is also compensated (by insurance or otherwise) for the reimbursed expenses.
These provisions of the Act mean that employers need not "gross up" qualifying payments in order to provide a minimum amount of after-tax relief to each employee. Moreover, the provisions allow all employees of a particular employer to receive equal benefits, since the amounts received will not be reduced by the individuals' income tax liability.
Certain Death Benefits Not Taxable As Income
The Act amends section 101 of the Code to provide that amounts paid by an employer due to the death of an employee will not be taxable as income if the death was a result of the Oklahoma City bombing, the September 11, 2001 attacks, or an anthrax-related attack between September 11, 2001 and January 1, 2002.
The Act does not specify the recipients to whom the tax exclusion applies, and thus appears to extend the exclusion to any person who would otherwise have income as a result of the payment (e.g., the individual's estate or survivors). The exclusion does not apply, however, to any payment that would have been made had the employee died other than as a specified terrorist victim or to victims of other disasters.
Tax Rules Relaxed For September 11 And Anthrax Disaster Relief Charities
Generally, organizations described in section 501(c)(3) of the Code and engaged in disaster relief efforts must make a formal determination of the needs of their grantees prior to distributing funds to them. This requirement was partly responsible for the delays (widely reported in the news media) in distributing the unprecedented level of funds raised by charities in response to the September 11 attacks.
Frustration with this slow distribution of funds led to the enactment of an exception, first announced by the Internal Revenue Service (IRS) in November and now endorsed and expanded by the Act, to the rules requiring a specific determination of need. Payments by qualified charitable organizations occurring by reason of individual death or injury connected with the September 11 attacks or anthrax-related attacks between September 11, 2001 and January 1, 2002 will be deemed consistent with the organization's exempt status, provided the payments are made in good faith and using a reasonable, objective and consistently applied formula. Furthermore, such payments by private foundations will not be treated as made to a disqualified person for purposes of self-dealing penalties under Section 4941 of the Code.
IRS Directed To Allow Company Foundations To Benefit Employees
In addition to the actual provisions of the Act, the Joint Committee on Taxation, in its technical explanation of the Act, directed the IRS to issue prompt guidance clarifying and relaxing the tax rules applicable to employer-controlled private foundations. While the Joint Committee report is not law, it is an expression of congressional intent and, as such, will presumably lead to the results it directs.
The Joint Committee report affects payments, based on objective determinations of need (i.e., by an independent selection committee or an adequate substitute procedure), made by employer-controlled foundations to employees affected by a qualified disaster and who are selected from a large and indefinite class of potential beneficiaries. The report concludes that, for payments meeting all such conditions, (i) no private inurement should result, (ii) no self-dealing penalties should be incurred, (iii) no taxable expenditure penalties should be incurred, and (iv) the distributions should count toward the foundation's minimum annual distributions. Further, the Joint Committee report provides that Section 102(c) of the Code, which provides that gifts from employers to employees are taxable to the employee, does not apply to payments made by employer-controlled foundations to employees of the employer.
The Joint Committee report indicates Congressional disapproval of the IRS's current ruling position on the formation of company foundations that provide disaster relief to company employees. Based on the expected IRS policy reversal, employers may wish to consider establishing a private foundation dedicated to providing disaster relief to employees.
Professional Advisors Should Be Consulted
Many provisions of the Act will present interpretive issues when applied to particular circumstances. Formal IRS guidance, while expected shortly, has not yet been issued. Moreover, the Act addresses many other provisions relating to September 11 in particular and to disaster relief in general that are not discussed in this Bulletin. Employers and charities should consult with their professional advisers prior to making disaster relief payments.