COVID-19, current travel restrictions, and government and business shutdowns have certainly made it difficult for many mobile employees to carry out “business as usual.” This can be particularly true for employees that were on a short-term or long-term assignment prior to COVID-19. Because of safety considerations or travel restrictions, two common scenarios that have emerged from the COVID-19 pandemic include:
- Scenario 1: Individuals that were on a short-term assignment (i.e., 1 year or less) are having their assignments extended.
- Scenario 2: Individuals that were on a long-term assignment (i.e., more than 1 year) are temporarily returning to their Home location or going to a different location.
In both scenarios, many companies are providing assistance to employees to help with either the additional costs of staying on assignment, such as in Scenario 1, or assistance with the costs of temporarily going back home or to a new location, as in Scenario 2. The additional costs of such assistance may be substantial, but there could be even more hidden costs for the company due to the following:
- Additional tax implications could result due to a change in where the employee was originally expected to be located. For example, an employee who remains in a location longer than anticipated could become subject to tax in that location because an income tax treaty no longer applies and/or because they have become a resident for Host location tax purposes. You can read more on this topic in one of our other recent blog articles.
- Payments made by the company to assist mobile employees that have an unexpected change in location may be considered taxable income if the individual is working in or is a tax resident of the location.
From a US federal income tax perspective, the Internal Revenue Code (IRC) defines taxable wages as all remuneration for services performed by an employee for their employer (both cash payments and non-cash benefits paid in any way other than cash), UNLESS specifically exempted by another IRC section. Here, one of the most well-known IRC sections that exempts payments from taxable compensation is IRC Section 162(a)(2), which is often referred to as the “business traveler exemption.” However, as shown in the following example, it is important to not assume this exemption will always apply, especially if facts change due to COVID-related issues.
Business Traveler Exemption
Under IRC Section 162(a)(2), an employee with a tax home in location A who is on a “temporary” assignment or business trip to location B can receive tax-free reimbursement of certain travel costs (e.g., reasonable housing, per diems) from their employer. Here, a temporary assignment would be defined as one that is expected to last and, in actual terms does last, for one year or less. If the assignment later is expected to go over the one-year mark, it will no longer be considered temporary, such that the travel costs no longer qualify for exemption under IRC Section 162(a)(2).
The following scenario illustrates this concept considering a possible COVID-related assignment extension.
Scenario 1 – Extended US Domestic Assignment
Assume an employee went on a temporary assignment from Florida to Tennessee on May 1, 2019 and was expected to complete their assignment on April 15, 2020. However, due to COVID-19, the employee decided to remain in Tennessee because perhaps their home in Florida was a COVID-19 hotspot or there were travel restrictions limiting their ability to travel back to Florida.
In this scenario, once the intent of the assignment was expected to exceed one year, the “business traveler exemption” would no longer apply (from that point onward), with all payments for housing, meals, and travel in Tennessee now subject to US federal taxation. Due to this factor, the change in taxability for the assignment costs could result in a very unpleasant surprise for the individual or company (if the company policy would cover the incremental tax costs for their employee).
In this example, as Florida state and Tennessee state do not have state income tax, a state income tax event would not be incurred. Although outside the scope of this blog, a review of state tax requirements should always be undertaken to determine the state income tax impacts.
In addition to domestic US scenarios, it is also critical to consider the ongoing applicability of IRC Section 162(a)(2) for employees who temporarily relocate due to COVID-related reasons. The following example illustrates this need for an employee and family who are temporarily returning to the US for safety considerations.
Scenario 2 – Temporary repatriation to the US
Assume an employee was on a 3-year assignment from the US to another country and started the assignment on January 1, 2019. During this assignment the employee’s family joined them and they rented out their house in their Home location for the duration of the assignment. Due to the COVID-19 pandemic, the employee returned to the US in March of 2020, and the company provided temporary housing for the employee and his family.
In this scenario, the travel back to the US could be deemed a “temporary assignment” if the individual’s tax home remained in the other country. Accordingly, the “business traveler exemption” could apply to have the housing, meals, and travel costs be exempt from taxable income, but only for the costs related to the employee. Any payments related to the family do not meet the requirements of IRC Section 162(a)(2) to be considered exempt from compensation. Accordingly, any of the following payments for the family would be considered taxable income:
- Housing costs in the US (i.e., the incremental cost of housing for the family beyond a one-bedroom place or similar housing that would normally be provided to an employee on a short-term assignment)
- Travel costs for the family to travel from the assignment location to the US
- Any meals/food for the benefit of the employee’s family
In addition to any US federal tax costs, it would also be necessary to consider whether the additional housing, travel, and meal costs would be subject to state tax or to tax in the non-US country. Once again, the taxability on these payments by the company could result in very unpleasant surprises for the employee and employer.
Section 139 to the Rescue?
While the “business traveler exemption” may not provide much relief to companies that are supporting changes in assignment locations for their mobile employees, there is another IRC section that could assist in limiting any unexpected tax bills.
Soon after the events of September 11, 2001, IRC Section 139 was added to the IRC as an instrument for private entities to provide disaster relief payments to individuals on a tax-free basis. The current pandemic is a “qualified disaster” for purposes of IRC Section 139 and will remain qualified until the President declares that the federally declared disaster condition has ended.
Qualified disaster relief payments are exempt from federal and most states’ personal income tax for the recipient and are exempt from federal tax withholding, FICA, FUTA, Medicare, and self-employment taxes for all parties if structured properly. Further, qualifying payments are still deductible business expenses for the employer, even though they are not taxable to the recipients. Some potential expense reimbursements that could qualify for relief under IRC Section 139 include:
- Housing: Expenses incurred for a hotel room due to quarantine
- Transportation: Expenses incurred as a result of COVID-19 including rental cars and parking expenses
- Meal: Expenses from delivery services as a result of restricted travel
- Remote work: Expenses associated with remote work arrangement as a result of the pandemic
- Medical: Expenses related to COVID-19
There is no specified dollar limitation on the amount of payments that may be excluded from income by operation of IRC Section 139; however, the expenses must be “reasonable and necessary” and your organization should document that the actual payments comply with their own policy (e.g., the amount of payment should be commensurate with the expenses for which the payment is being made.) Also, it is important to note that payments for income replacement purposes, such as payments to individuals for lost wages or unemployment compensation, are not eligible for tax relief.
As mentioned above, the ultimate taxation of traveling costs can vary depending on the locations involved (e.g., states and/or countries) and the specific facts and circumstances. If you have any employees that fit the fact patterns described above, and you would like to explore if IRC Sections 162(a)(2) or 139 could reduce your employee or company’s overall tax cost, please contact us and we would be happy to provide assistance.