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Two Tax-advantaged Pay Plans for Retaining Hourly  Workers during COVID-19

August 24, 2020 - minute read

As the COVID-19 crisis continues—creating elevated health risks for some hourly workers and financial hardship for others—more employers are considering ways to keep valued employees on board.  

Two tax-advantaged pay plans are receiving particular attention: disaster payment plans and supplemental unemployment benefit plans. At the least, employers currently focused on employee retention should know what they are, how they work, and their pros and cons.

Understanding Disaster Relief Payment Plans: What They Are

According to Internal Revenue Code Section 139, once a federal disaster has been declared, employers can make “qualified disaster relief payments” to employees. These payments are both deductible to employers and tax-free to employees. When President Trump declared a national emergency on March 13, 2020, he opened the door to these beneficial plans.

As the name implies, qualified disaster relief payments are used “to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster.” They are not intended to cover lost wages or expenses that would be covered by insurance.

How Disaster Relief Payment Plans Work

While the IRS has yet to offer specific guidance relative to COVID-19, legal experts believe that the following expenses will fall under Section 139:

  • Out-of-pocket medical expenses not covered by insurance
  • Childcare and tutoring expenses
  • Expenses incurred to allow employees to work from home
  • Funeral expenses

Employers interested in creating a disaster relief payment plan should first define:

  • Employee eligibility
  • Qualified expenses
  • Procedures for employees to request reimbursement and employers to respond.

While creating a written disaster relief payment plan isn’t required, it is strongly recommended in the event of an IRS audit.

Pros and Cons

Disaster relief payment plans offer a number of advantages, including:

  • They offer targeted aide to workers impacted by COVID-19 (the childcare benefit may be of particular value)
  • They are tax-deductible to employers
  • They are tax-free to employees
  • They can be established relatively quickly

Disaster relief payment plans offer few disadvantages, other than investing the time and thought to create a detailed written plan and avoid potential tax headaches. Payments can be made until the President declares that COVID is no longer a national disaster.

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Understanding Supplemental Unemployment Benefit Plans: What They Are

While disaster relief payments are designed to assist active employees, supplemental unemployment benefit plans—aka SUB plans or SUB pay plans—are designed for furloughed and laid-off employees. As the name implies, SUB plans augment state-paid unemployment benefits. These can be created as either tax-exempt plans or trusts, as established under IRS code Section 501(c)(17).

While some employers offer them to workers during permanent reductions-in-force in lieu of severance, they are also ideal for furloughed workers that employers plan to eventually bring back. The idea: by providing workers with a fuller income, employers hope workers will be incentivized to remain available and wait to be called back.

How Supplemental Unemployment Benefit Plans Work

In order to be eligible for SUB pay, workers must be eligible for unemployment. When unemployment benefits end, so does SUP Pay. Every state has its own rules requiring SUB plans; some require employers to obtain state approval before moving forward.

SUB plans are often viewed as a more affordable, cash-flow friendly alternative to traditional severance plans. Here’s how they compare:

  • Unlike severance, SUB payments are treated as benefits—not wages—and are therefore exempt from payroll taxes for employers and employees.
  • Unlike severance benefits, which are paid lump sum, SUB payments are paid out over time, offering greater cash-flow flexibility to employers.
  • In most states, severance benefits may reduce or negate unemployment benefits. In contrast, SUB pay does not impact unemployment benefits in most states.

SUB pay can be paid from an employer’s general assets or through a tax-exempt trust. While creating a trust offers additional tax advantages, this takes longer to implement, since the trust requires IRS approval.

Unlike disaster relief payment plans, establishing a SUB plan is a lengthy legal and administrative process. Furthermore, it is currently unclear how the CARES Act impacts SUB plans and vice versa.

Pros and Cons

SUB plans offer a number of advantages, including:

  • They incent valued laid-off workers to remain available until they can be called back
  • Both employers and employees are exempt from payroll taxes      
  • They are more cost-effective than traditional severance plans

On the flip side, they are time and labor intensive to implement and manage, which may make more appropriate as part of a long-time retention strategy—say, in a seasonal industry—versus a response to COVID layoffs.

Solutions for Managing through COVID-19

COVID-19 has created unprecedented challenges for employers in every regard, but particularly when it comes to their workforce. EPAY Systems is committed to helping employers—especially those managing hourly and distributed workers—during this challenging, rapidly-shifting time. For more ideas and solutions, visit our Coronavirus Resource Center.

Filed Under: Payroll & Tax COVID-19