Hurricanes Harvey, Irma and Maria, and the recent wildfires in California have affected millions of people and led to an outpouring of charitable gifts and donations, including contributions from businesses with employees in the path of the disasters.
Like individuals, businesses generally can make tax-deductible contributions to charitable organizations for disaster relief or any other charitable purpose. Businesses can also give money to employees affected by disasters (though such giving normally is included in the employee’s income as additional compensation unless an exception applies).
For some businesses that are committed to providing relief to employees affected by disasters, however, there is a third option: organizing an employer-sponsored public charity or private foundation. These employer-sponsored charities offer several attractive benefits: tax deductibility of contributions (assuming the donor itemizes deductions), tax exemption for the charity or foundation’s income, and tax exclusion for recipients, as well as the ability for the organization to focus its disaster relief activities on a relatively small group of people, i.e., the employees and former employees of a particular company and their families.
Historically, the IRS was reluctant to allow employer-sponsored public charities or private foundations to provide disaster relief to employees of the sponsoring employer, out of concern such relief conferred a private benefit on the sponsoring employer. After the terrorist attacks of Sept. 11, 2001, however, the IRS reconsidered. The IRS now allows employer-sponsored charitable organizations to offer disaster relief to employees of the sponsoring company, so long as three conditions are satisfied:
1. The class of beneficiaries is large or indefinite;
2. Recipients are selected based on an objective determination of need; and
3. Recipients are selected by an independent selection committee, or adequate substitution procedures are in place to ensure that any benefit to the sponsoring employer is incidental and tenuous.
1. Charitable Class
As a general rule, a charity must benefit a “charitable class” and not a particular person or pre-selected group of people. A charity cannot be formed to assist a single individual, for example, no matter how sympathetic or deserving. The charitable class requirement does not mean that a charity must actually provide relief to all potential beneficiaries. Rather, the class need only be large enough that potential beneficiaries cannot be identified in advance.
If the group of potential beneficiaries is limited to a relatively small group, such as the employees of a particular employer, the group must be indefinite. The IRS will consider a group indefinite where it includes not only employees affected by a current disaster, but also employees who may be affected by future disasters. Thus, a company could not form a charity for the sole purpose of assisting an employee who lost a home in Hurricane Harvey, but might be able to provide relief to that employee through a charity formed to assist victims of Hurricane Harvey and future disasters.
Very small employers may be unable to show that a company-sponsored charity benefits a charitable class, because the group of potential beneficiaries simply is too small. Companies with a few thousand or even a few hundred employees, however, should be able to satisfy the charitable class requirement, particularly if disaster relief is available to former employees and the families of current and former employees, in addition to current company employees.
2. Determination of Need
An employer-sponsored charity may provide certain kinds of relief, including rescue services, blankets, water and hot meals without regard to financial need because even financially secure people may be in need of essentials in the immediate aftermath of a disaster. As time goes by, however, charities must make an objective assessment of each recipient’s resources before providing financial aid. This requirement addresses the IRS’s concern that an employer-sponsored charity not be used to pay what is, in essence, additional compensation to the employees of the sponsoring employer.
If an executive of a company loses her home to a storm, for example, but the executive has the resources to rebuild or buy a new home, the executive will not qualify as being financially in need—though she may be in need of food, water, clothing or shelter in the immediate aftermath of a storm.
3. Independent Selection Procedures
An employer-sponsored charity must maintain independence from the sponsoring employer. The purpose of this requirement is to prevent company-sponsored charities from being used improperly to benefit the sponsoring employer by, for example, contributing to employee recruitment or retention.
The IRS will consider a charity’s selection committee to be independent if a majority of its members are not able to exercise substantial influence over the affairs of the employer. For example, a sponsoring employer cannot appoint its entire board of directors or the majority of its board as the directors of the employer-sponsored charity’s selection committee. An employer could, however, appoint one or two board members, so long as the appointees do not make up the majority of the selection committee and are not able to exercise undue influence over the selection process.
Kinds of Relief
Like other charitable organizations, employer-sponsored charitable organizations are classified either as public charities or private foundations, depending on the sources of their support, and the entity’s classification will affect the kind of relief it can provide to employees of the sponsoring employer.
In general, a public charity receives financial support from the general public, which, in the case of an employer-sponsored public charity, may include a cross-section of employees from a sponsoring company, as well as the company’s clients, customers, suppliers and others. Because they are supported by a broader group of people, public charities are considered more transparent and are allowed greater leeway in their activities. An employer-sponsored public charity, in particular, may provide relief not only in the case of a qualified disaster, but also in the case of an employee personal hardship situation, such as an illness or personal casualty loss.
Private foundations, on the other hand, are supported exclusively or predominantly by a single individual, family or employer, and, as a result, there are more rules and restrictions on a private foundation’s activities, including restrictions on deducting contributions above a certain threshold and excise taxes on prohibited transactions. Employer-sponsored private foundations that provide relief to the sponsoring company’s employees may do so only in the case of a “qualified disaster,” which includes a federally declared disaster, accidents involving common carriers, and disasters resulting from terrorist attacks or military action, but excludes personal hardship situations not caused by a qualified disaster.
Employers that desire more flexibility to provide relief to employees facing personal hardship situations may be able to qualify as public charities by, among other things, receiving contributions from employees, customers, clients, suppliers and others.
State Filing Issues
In addition to the federal income tax rules applicable to employer-sponsored public charities or private foundations, there are state-specific rules that charities must comply with in order to operate effectively. Most (though not all) states require charities to register, for example, if they will be soliciting funds or making distributions in the state.
Unfortunately, there is no uniform or 50-state registration procedure, which can make the state registration requirements far more burdensome than the federal rules for charities that intend to solicit funds in most or all 50 states. The state rules may be less daunting for charities that intend to operate in only one or a few states, however, or for private foundations that will be funded solely by a sponsoring employer, and thus, will not solicit contributions at all. In either case, however, employer-sponsored charities generally will be required to register in each state in which the charity intends to operate or solicit contributions.