I first came across this specific area of our tax code courtesy of Tony Nitti, a tax practitioner who regularly writes for Forbes magazine. I will share a snippet of what Section 139 is and how it applies to business owners and their employees facing hardship from COVID-19. From Nitti’s blog directly
Section 139, however, provides that in the worst of circumstances, an employer can make a tax-free payment to an employee. In addition to contemplating the type of terrorist attack for which it was originally designed, Section 139 also applies to any “federally declared disaster” as defined in Section 165(i)(5)(A). Section 165, in turn, defines such a disaster as any disaster determined by the President to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.
As outlined earlier in this article, when employing Section 7508A to delay the April 15th tax deadline in Notice 2020-18, the IRS stated that the President’s emergency declaration constituted a federally declared disaster for purposes of Section 165. Thus, the COVID-19 pandemic satisfies the requirement in Section 139 of a federally declared disaster.
As a result, beginning immediately, employers may provide tax-free payments to employees — while still claiming a full deduction for the payments — provided the payment is to reimburse or pay the employee for “reasonable and necessary personal, family, living, or funeral expenses” incurred as a result of COVID-19.
Payments are NOT covered by Section 139 if they compensate employees for expenses that are otherwise compensated for by insurance or that are intended to replace lost income. Thus, payments of sick pay or family medical leave remain fully taxable to the employee.