After passage of the Pension Protection Act in 2006, employer hardship funds sponsored by a charitable organization (“sponsored hardship funds”) potentially became a problem for employers and the sponsoring organization. Section 4966 of the Internal Revenue Code (“IRC”) defined such funds as ‘‘donor advised funds” and imposed taxable “distributions” from the funds on fund managers and recipient individuals. Distributions to individuals were taxable with certain exceptions.
Pursuant to authority in IRC § 4966(d)(2), the Treasury Department and the Internal Revenue Service (“IRS”), in § 5.01 of IRS Notice 2006-109, exempted grants to employees from sponsored hardship funds. Although sometimes disregarded, the Notice also contained the following cautionary observation:
Satisfaction of the above requirements does not affect the determination of whether any payments made from the Fund might result in taxable compensation to the employees.
The warning indicates that there is a potential federal tax problem for recipients of grants from sponsored hardship funds. Further, IRC § 61 provides that income of an individual from whatever source is taxable except where there are exceptions in the IRC. There are two exceptions which are pertinent. These are found in IRC § 139 and IRC § 102(a). Both these IRC sections are relevant not only for grants from sponsored hardship funds, but also for employer grants, federal and state governmental grants to alleviate hardship, and grants from individual donors to individuals for that purpose.
Two types of grants are addressed by IRC § 139 and the relevant Revenue Rulings describing the relevance of IRC § 102(a). The first type of grant is one to alleviate immediate suffering and damage from a disaster (“general welfare grants”). The second type is to mitigate damages, essentially grants for rehabilitation of personal injuries or damage to real and personal property (“mitigation grants”).
IRC § 139 exempts both general welfare grants and mitigation grants from inclusion in the taxable income of a recipient given because of “qualified disasters.” These are:
- a disaster which results from a terroristic or military action (as defined in 692(c)(2));
- a federally declared disaster (as defined by 165(i)(5)(A));
- a disaster which results from an accident involving a common carrier, or from any other event, which is determined by the Secretary to be of a catastrophic nature; or
- with respect to amounts described in subsection (b)(4), a disaster which is determined by an applicable Federal, State, or local authority (as determined by the Secretary) to warrant assistance from the Federal, State, or local government or agency or instrumentality thereof.
But what about grants for a hardships occurring during a period which is not a qualified disaster? To answer the question, it is necessary to refer to IRC § 102 and Rev. Rul. 2003-12 (2002).
Working from the General Rule in IRC § 102(a) which states that gross income for tax purposes does not include the value of property acquired by gift, the IRS has developed an exclusion, according to Rev. Rul. 131 which covers grants from funds which fit the description of sponsored hardship funds described in § 5.01 of IRS Notice 2006-109. To illustrate how the exclusion works, Rev. Rul. 2003-12 developed the following fact situation:
Situation 2, the grants made by O are designed to help distressed individuals with unreimbursed medical, temporary housing, or transportation expenses they incur as a result of the flood. Under these facts, O’s grants are made from detached and disinterested generosity rather than to fulfill any moral or legal duty. Thus, the grants are excluded from the gross income of the recipients as gifts under § 102. Because payments by non-governmental entities are not considered payments for the general welfare, the grants made by O are not excluded from the recipients’ gross income under the general welfare exclusion. Rev. Rul. 82-106, 1982-1 C.B. 16. It is not necessary to reach the question of whether § 139 applies to the grants.
Rev. Rul. 2003-12 modified Rev. Rul. 131 for employer and federal and state grants to as to the exclusion from a recipient’s gross income. General welfare grants from charitable organization funds as described in the fact situation quoted immediately above, however, remained excludable from gross income as a gift under IRC § 102. The Revenue Ruling determined that grants made in the fact situation were “made out of detached and disinterested generosity rather than to fulfill any moral or legal duty.”
Thus, the grants are excluded from the gross income of the recipients as gifts under § 102. Rev. Rul. 2003-12 states:
“2) Payments that individuals receive under a charitable organization’s program to pay or reimburse unreimbursed medical, temporary housing, or transportation expenses they incur as a result of a flood are excluded from gross income under § 102.”
In summary, both general welfare grants and mitigation grants from sponsored hardship funds are not included in the gross income of recipient employees if the hardship is the result of a qualified disaster. Such grants are, therefore, not taxable to the recipient. Only general welfare grants from sponsored hardship funds are not included in the gross income of recipients, and, therefore, not taxable to the recipient, when the hardship is not the result of a qualified disaster. Significantly also, this is reason for an employer to use a sponsored hardship fund rather than one where the grants come from an employer established fund without a sponsoring intermediary. Rev. Rul. 2002-12 states that grants from employer established funds do not meet the requirements for the general welfare exclusion where the disaster is not a qualified one.