Employee Benevolence in the Nonprofit World
Payments from a nonprofit employer to an employee are usually taxable, even when intended as hardship assistance. Two possible options may be available:
Qualified disaster relief payments under 26 U.S.C. § 139
Assistance provided through a separate 501(c)(3) public charity
Each option has strict requirements. Nonprofits should carefully structure an employee assistance program before distributing funds.
Nonprofit employers often retain employees who, just like employees in the for-profit sector, experience hardships, difficulties, and financial need. Natural disasters, medical emergencies, and other unexpected events affect nonprofit staff members in the same way they affect other workers.
In response to these hardships, nonprofit organizations, particularly charitable nonprofits, often desire to help employees weather those storms.
There is just one problem. If a nonprofit employer gives money directly to an employee, even when that money is intended to help with a legitimate financial need, the payment is generally considered taxable income to the employee. This differs from the nonprofit’s provision of similar charitable support to a non-employee, which may be tax-free.
Under 26 U.S.C. § 61, the default rule is that taxable gross income includes payments made by a nonprofit employer to an employee unless federal law provides a specific exemption.
One exemption appears in 26 U.S.C. § 102, which provides:
“Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.”
Unfortunately, Congress specifically excluded gifts made by employers to employees from this exemption. See 26 U.S.C. § 102(c)(1).
Although these rules are broad and not easily avoided, there are several narrow options for a nonprofit that wants to provide tax-free charitable support to employees experiencing financial need.
Option 1: Qualified Disaster Relief Payment
Congress created a specific exception to the broad definition of gross income when it passed 26 U.S.C. § 139. This law states:
“Gross income shall not include any amount received by an individual as a qualified disaster relief payment.”
Page 14 of IRS Publication 3833 further explains:
“Qualified disaster relief payments from any source, including employers, reimbursing or paying individuals’ specified expenses in connection with qualified disasters are not taxable as income and are not subject to employment taxes or withholding.”
To qualify for this treatment, the payment must cover expenses incurred by the employee as a result of a qualified disaster. The payment must be used to address the employee’s personal or family needs caused by the disaster or to repair or replace the employee’s home or property damaged by the disaster.
Organizations should also document the nature of the disaster, the employee’s eligible expenses, and the basis for the payment.
What Counts as a Qualified Disaster?
This option is limited by the federal definition of a “qualified disaster.” Under the statute, and as explained on page 15 of IRS Publication 3833, the term is limited to an event that:
“Results from terrorist or military actions”
“Results from an accident involving a common carrier”
“Is a Presidentially declared disaster”
“Is an event that the Secretary of the Treasury determines is catastrophic”
This list excludes many events unrelated to military action, terrorism, or a qualifying governmental declaration. For example, an employee who is experiencing financial hardship because of a sick relative’s medical bills would not qualify under this exception.
The definition may also exclude some natural disasters, including a local flood, tornado, or wildfire, if the event has not been officially treated as a qualified disaster by the federal government. Before treating a payment as tax-free, the organization should confirm that both the event and the employee’s expenses satisfy Section 139.
Option 2: Separate 501(c)(3) Public Charity
Because Option 1 is quite narrow, some nonprofits consider a different solution that does not depend entirely on the occurrence of a hurricane, terrorist attack, or other qualified disaster. A second option is the establishment of a separate 501(c)(3) public charity.
Under this model, the nonprofit employer transfers money to the separate public charity. The charity may then make tax-free charitable contributions to needy employees of the nonprofit, provided the arrangement satisfies applicable IRS requirements.
The separate public charity cannot merely act as a pass-through for payments directed by the employer. It must administer the program independently and make grant decisions based on charitable criteria.
The two options differ significantly in scope, administration, and eligibility:
-
Limited to qualified disasters
Employer may make the payment directly
Payment must cover eligible disaster-related expenses
Governed primarily by 26 U.S.C. § 139
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May cover a broader range of charitable hardships
Assistance is provided through a separate charity
Grants must be based on objective financial need
Requires an indefinite charitable class and independent selection
Several additional requirements are especially important when using a separate public charity.
Who May Receive Assistance?
First, the group of people eligible to receive charitable assistance from the separate public charity, commonly called a “charitable class,” must be “large or indefinite” under IRS rules.
Generally, this means that the public charity’s assistance must benefit the needy people of a city, state, or region rather than a predetermined set of individuals. However, the IRS has specifically addressed programs limited to the employees of a particular employer:
“If the group of eligible beneficiaries is limited to a smaller group, such as the employees of a particular employer, the group of persons eligible for assistance must be indefinite. To be considered to benefit an indefinite class, the proposed relief program must be open-ended and include employees affected by the current disaster and those who may be affected by a future disaster.”
In practical terms, the program should not be created only to benefit one named employee or a small, predetermined group. It should remain open to current and future employees who may later experience a qualifying hardship.
How Should Financial Need Be Evaluated?
Second, recipients of the public charity’s assistance must be objectively needy. An individual is not necessarily needy merely because the person was affected by a natural disaster or other hardship.
Under IRS guidance:
“[The public charity’s] decision about how its funds will be distributed must be based on an objective evaluation of the victims’ needs at the time the grant is made.”
In other words, the public charity should evaluate each request based on the recipient’s actual circumstances. Relevant considerations may include the employee’s financial resources, insurance proceeds, assistance from other sources, family circumstances, and the amount and type of expenses incurred.
The charity should also evaluate need on an ongoing basis because an individual’s financial condition may change over time.
Who Should Select the Recipients?
Third, recipients of the public charity’s support must be selected by an independent selection committee.
IRS Publication 3833 provides:
“The charity’s selection committee is independent if a majority of the members of the committee consists of persons who are not in a position to exercise substantial influence over the affairs of the [nonprofit] employer.”
This requirement helps prevent the employer from using the charitable program to provide additional compensation, reward favored employees, or control the distribution of grants.
The committee should apply written eligibility standards consistently, document the basis for its decisions, and avoid conflicts of interest. The nonprofit employer may fund the program, but it should not control which employees receive assistance or how much each employee receives.
Is an Employee Benevolence Program Right for Your Nonprofit?
A well-structured employee benevolence program may allow a nonprofit to respond compassionately when an employee experiences a serious hardship. However, good intentions alone do not make an employer payment tax-free.
If your nonprofit is considering a charitable assistance program for its employees, Church & Charity Law can help you evaluate the available options and structure the program appropriately. Call our office at (918) 392-1956 or contact us today to schedule a consultation.
Disclaimer: This article and all other content on this website are provided for general informational purposes and are not legal advice. To obtain legal advice concerning your specific circumstances, please contact our office.