Key takeaways
- Employers can provide tax-free cash assistance to employees affected by the California wildfires under U.S. tax law, with payments covering necessary personal expenses not reimbursed by insurance.
- Employees may access retirement funds through hardship distributions from 401(k) or 403(b) plans for disaster-related expenses, subject to income tax and potential penalties.
- Meanwhile, the SECURE 2.0 Act allows penalty-free distributions up to $22,000 with flexible repayment and tax options.
- Employers can establish leave donation programs that allow employees to donate PTO to colleagues affected by the disaster, ensuring tax-free treatment for donors and IRS compliance.
- Employers should consider implementing formal policies and documentation processes to effectively support affected employees and take advantage of available tax benefits.
As those affected seek to recover and rebuild from the devastating wildfires in California, employers are likewise seeking options to support their employees who have been affected. The California wildfires were declared a federal major disaster by President Biden as of January 8, 2025.
Section 139 programs
Section 139 of the Internal Revenue Code allows employers to provide cash assistance to employees affected by a qualified disaster (and take a deduction for those payments) and allows employees to exclude the amounts they receive as “qualified disaster relief” from federal income tax. Given the federal major disaster declaration for the California wildfires as of January 8, 2025, section 139 benefits may be utilized to assist with certain personal expenses attributable to the California wildfires.
In general, to qualify under section 139, in addition to the existence of a “qualified disaster,” payments must be for the purpose of paying or reimbursing the employee’s reasonable and necessary personal, family, living or funeral costs incurred as a result of the qualified disaster and/or expenses to repair or rehabilitate a personal residence to the extent that need is due to the qualified disaster, provided the amounts are not otherwise reimbursed or reimbursable through insurance. Section 139 programs can vary from employer to employer in design, and are available to for-profit and tax-exempt employers (although tax-exempt employers cannot take a deduction). An employer that wants to take advantage of the section 139 tax rules above should have a formal written policy or program in place and will need to implement a process to retain substantiation of payments and benefits provided.
Disaster distributions from qualified plans
With the presidential disaster declaration, certain in-service distribution options may also be available under an employer’s 401(k) or 403(b) retirement plan. Specifically, many plans allow for hardship distributions for “immediate and heavy” financial need, with one possible criterion being a qualified disaster if the employee’s principal residence or principal place of employment is within the disaster area (and additional potential criteria including casualty loss or damage to a principal residence, medical expenses and funeral expenses). Hardship distributions are generally subject to income tax and, if the recipient is under age 59 ½, a 10% early withdrawal penalty.
In addition to hardship withdrawals, as a result of the SECURE 2.0 Act of 2022, retirement plans may make available to participants in-service “qualified disaster relief distributions” of up to $22,000 if the participant’s principal residence or principal place of employment is within a federally-declared major disaster area, the participant has suffered economic loss due to the disaster and the distribution is requested within 180 days of the date of the disaster declaration. Unlike hardship withdrawals, qualified disaster relief distributions do not require attestation of “immediate and heavy financial need” and are not subject to the 10% early withdrawal penalty. In addition, they may be eligible for repayment to the plan or another plan that will accept rollovers, and participants have the option to spread taxation of the amount over three tax years.
The availability of these options depends on the terms of the employer’s plans. Many plans have not yet been updated to permit qualified disaster relief distributions and not all offer hardship distributions. However, employers may be able to retroactively amend their plans to permit these distribution types, if desired.
Leave donation programs
Employers can assist employees during a federally declared disaster by creating paid “leave banks,” which allow employees to donate their paid time off or vacation (PTO) to other employees affected by the disaster. Bona fide employer-sponsored leave banks allow a donor employee to avoid taxation on the value of the PTO and only tax the payment to the recipient employee. Leave bank programs must be documented in writing and contain certain provisions, such as restricting a donor employee from specifying the recipient of the payment, reasonable restrictions on the timing for the donation and use of the donated amounts, and provisions for returning any unused amounts to the original donors.
For further information
In addition to working with many of our colleagues who have been personally affected by the wildfires, Reed Smith is at the forefront of helping our clients implement relief efforts for affected employees in a tax-advantaged manner. If you have questions about these options or other employee benefits matters, please contact the Reed Smith attorney with whom you work or reach out directly to any of the authors listed above.
Client Alert 2025-026