As the entertainment industry continues to adjust to a new normal, a largely forgotten provision of the Internal Revenue Code may provide welcome relief to both entertainment businesses and their employees during these uncertain times. The provision would allow individuals to receive tax-free payments from their employers while still giving employers the benefit of a deduction for such payments. The tax relief in question hearkens back to an earlier national crisis: following the September 11 terrorist attacks, Congress passed the Victims of Terrorism Tax Relief Act of 2001, which was intended to provide federal tax relief to victims of national disasters. Among the tax provisions to stem from this legislation was Internal Revenue Code Section 139 (Section 139).
Section 139 permits individuals to exclude from gross income for federal income tax purposes payments from any source (including an employer) that are qualified disaster relief payments. Qualified disaster relief payments include, among other things, payments and reimbursements for reasonable and necessary medical, personal, family, living, or funeral expenses that are incurred by an individual as a result of a qualified disaster[1] and not otherwise compensated (e.g., by insurance). Significantly, employers are able to deduct such payments for federal income tax purposes. Section 139 payments are also not subject to any federal withholding obligations and, therefore, do not need to be reported on a Form W-2 or 1099.
The disruption created by COVID-19 has given rise to a number of expenses that may fall within the scope of Section 139. Possible examples of such expenses include medical expenses for COVID-19 treatment that are not covered by medical insurance (including over-the-counter medication), dependent care expenses (including remote learning expenses for children), and home office expenses incurred as a result of implementing a work-from-home setup. It should be noted, however, that payments in the nature of a wage replacement will not qualify under Section 139 and will thus remain taxable. Further, as noted above, payments under Section 139 must be reasonable and necessary to qualify for the gross income exclusion; nonessential, luxury, or decorative items or services will not qualify. Accordingly, while not statutorily required, employers would be prudent to implement a written policy outlining the parameters of their Section 139 programs. Additionally, while the statute does not require record keeping, it is still recommended that employers keep records with supporting documentation for any payments or reimbursements made to workers in accordance with a Section 139 program in order to bolster the position that such payment or reimbursements were within the “reasonable and necessary” parameters of the statute.
Many entertainment businesses, including production companies and loan-outs, may be able to make payments or reimbursements that qualify for Section 139 treatment as long as such payments are (i) reasonable and necessary, (ii) related to the COVID-19 pandemic, and (iii) not otherwise compensated by insurance or otherwise. One example might be a production company whose workers have largely made the transition to working from home as a result of quarantine orders. If the production company opts to reimburse its workers for any expenses incurred in setting up a home office, such reimbursement may fall within Section 139 and therefore be tax-free to the workers and deductible by the production company. Alternatively, in lieu of reimbursements, the production company could receive the same tax treatment by implementing a Section 139 program and paying its workers an amount that is reasonably calculated to cover work-from-home expenses. The above benefits may also be available to shareholder-employees of a loan-out company.
The above examples are illustrative and should not be relied on as guidance or legal advice. Whether certain expenses qualify for tax-free treatment under Section 139 is determined on a case-by-case basis and is based on the facts and circumstances of the payment. Venable stands ready to advise any clients who wish to include Section 139 in their tax planning.
[1] The IRS confirmed that COVID-19 is a qualifying disaster for purposes of Section 139 in a FAQ published March 31, 2020.