Introduction
Our goal is to provide useful tax and financial information to those affected by major casualties and disasters, and their advisors. ((See generally these tax rules: Sections 139(c)’ and 165(c)’, 7508A. If you are a tax professional, see “Disaster Relief Resource Center for Tax Professionals,” https://www.irs.gov/tax-professionals/disaster-relief-resource-center-for-tax-professionals.))
We mention the effects of Hurricane Harvey in and around Houston beginning in August, 2017, and Hurricane Irma that hit Florida and its environs soon after, and then the terrible fires in Northern California in October. Catastrophic disasters have been ongoing.
Harvey has been described as the worst flood disaster ever in the continental United States. Just in and around Houston, FEMA believes some 68,000 homes were flooded. ((“Spared from Harvey’s worst,” Ralph Vartabedian and Ben Welsh, Los Angeles Times, 11/19/17, p. A17.))
On the heels of Hurricane Harvey, there has been reportedly the biggest evacuation in U.S. history in Florida due to Hurricane Irma. The effects of Hurricane Maria in Puerto Rico, a U.S. territory entitled to FEMA aid, whose citizens are U.S. citizens, have been devastating. ((“Puerto Rico’s Storm of Misery,” 60 Minutes program of 11/5/17 mentioned some 250,000 homes destroyed or damaged. Note that the tax rules relating to Puerto Rico are beyond our scope. See generally CBS Minnesota, “What is Puerto Rico’s Relationship to the U.S.?,” 9/26/17, Heather Brown. http://minnesota.cbslocal.com/2017/09/26/good-question-puerto-rico/; “Puerto Rico, What Other Americans Should Know,” Maggie Astor, New York Times, 9/25/17, https://www.nytimes.com/2017/09/25/us/puerto-rico-hurricane-american.html?mcubz=0.))
The recent fires in Northern California, taken together, have “surpassed the state’s fire-death record.” ((“Wildfire Victims Had Only Seconds to Make Choices,” Sarah Randazzo, Erin Ailworth, Ian Lovett, Wall Street Journal, October 16, 2017, p. A-1.))
As of mid-October, 2017, sixteen separate weather and climate disasters have caused at least a billion in damages in the U.S. ((USA Today, 10/19/17, p. 1. The full article is “$1 billion disasters: 2017 is already one of the worst,” Doyle Rice, Jim Sergent, George Petras, and Janet Loehrke, p. 4A. )) As of late October, the measure was losses of $3.3 billion just from the Northern California fires. ((“Update-2 – California insurance agency: wildfire losses at $3.3 bln, rising,” Reuters, 10/31/17; https://af.reuters.com/article/commoditiesNews/idAFL2N1N6297.))
With the tragedies and horrific costs, there are issues of insurance recoveries and governmental help. Part of recovering from disasters is in the financial details, and among the more complex of those details is asserting deductions. There are many financial decisions and accounting topics that may require analysis when disaster strikes.
Recovery is critical but planning for disasters is also important for the typical family and sophisticated business / financial enterprise.
As we write in November, 2017, and try to assess possible legislative changes to the disaster/casualty loss deduction, it seems likely business casualty losses will not be disturbed and personal casualty losses will not be diminished in 2017, but post-2017 personal casualty losses may be at some risk of repeal or diminution. ((https://waysandmeansforms.house.gov/uploadedfiles/bill_text.pdf.)) The Senate version of Republican proposed tax legislation would generally repeal the personal casualty loss deduction unless related to disaster losses.
Navigating the Difficult, Extraordinary Environment
The devastation crosses all boundaries, creating harm of a personal, investment and business nature. ((In general, see the following helpful IRS site: “FAQs for Disaster Victims,” ((https://www.irs.gov/businesses/small-businesses-self-employed/faqs-for-disaster-victims. On preparedness, see also “Disasters and Financial Planning, A Guide for Preparedness and Recovery,” Red Cross and the American Institute of CPAs, 2004; http://www.aicpa.org/InterestAreas/PersonalFinancialPlanning/Resources/ConsumerContent/DisasterFinancialIssues/DownloadableDocuments/Preparedness.pdf.))
The tax rules governing casualties are one of the rare exceptions for tax relief for purely personal losses.
Flood insurance is often inadequate for all but the larger companies. Some early estimates are that around 70% of the residential losses will be uninsured. ((“Insurance Often Won’t Cover Floods,” Leslie Scism and Nicole Friedman, Wall Street Journal, 9/2-3/17, B1.))
Individuals and smaller private companies are often relegated to the National Flood Insurance Program. The current program does not include business interruption insurance. Reimbursements are often inadequate to fully cover losses.
Yet it is also true that some benefit economically, some even immediately. These circumstances of unexpected economic benefit raise their own set of tax issues.
The devastation is widespread, but the devastation is sometimes followed by “construction booms” in the rebuilding. ((Josh Zumbrun, “Gulf Coast Faces Billions in Damages,” Wall Street Journal, , August 29, 2017, p. A-5.))
There will undoubtedly be much discussion of infrastructure relative to growth and emergency preparedness and other “big picture” dialogue. But the main focus in the affected areas remains how individuals and businesses recover from circumstances of severe loss.
In general, keep in mind capturing important documents – business records, auto registration, insurance records, etc. The first step to recovery is often documenting the relevant facts including before and after photos. Economic benefits usually begin with establishing the facts, measuring the damage.
IRS Relief Generally
The initial IRS relief announcements discuss the casualty loss deduction, but the initial focus of the IRS announcements was on penalty relief and extensions of due dates for individuals who live, and businesses who are located in the disaster areas, as well as taxpayers whose records are in the covered area.
Helpful websites and announcements are numerous. ((See generally “Hurricane Harvey,” https://www.usa.gov/hurricane-harvey; “Tax Relief for Victims of Hurricane Harvey in Texas,” Tx-2017-09, 8/29/17 and updated to 9/5/17; .Victims of Hurricane Harvey,” https://www.irs.gov/newsroom/help-for-victims-of-hurricane-harvey. Writing shortly after Irma makes landfall in the continental United States, the IRS was beginning to contribute information that focuses on Irma victims; the initial one focusing on the U.S. Virgin Islands. “Tax Relief for Victims of Hurricane Irma in U.S. Virgin Islands,” https://www.irs.gov/newsroom/tax-relief-for-victims-of-hurricane-irma-in-us-virgin-islands; “Help for Victims of Hurricane Irma,” https://www.irs.gov/newsroom/help-for-victims-of-hurricane-irma. “Disaster Relief Resource Center for Tax Professionals,” https://www.irs.gov/tax-professionals/disaster-relief-resource-center-for-tax-professionals. “Tax Relief in Disaster Situations,” https://www.irs.gov/newsroom/tax-relief-in-disaster-situations. See generally disasterassistance.gov and fema.gov. The updates and possibly new IRS sites are in such a dynamic state that it won’t be possible to keep this footnote updated. ))
The IRS pronouncements mention not only businesses and individuals but Forms 5500 (employee benefit plans) and exempt organizations.
The IRS will waive penalties related to late filing or late payment within certain defined time frames associated with the disaster. There is general relief in terms of deadlines and penalties when there is a casualty loss in a federal disaster area. ((Section 7508A, Regs. 301.7508A-1.))
The IRS will waive fees and expedite requests for getting copies of prior tax returns. ((See Form 4506, and Form 4506-T (transcripts).))
Estimated tax relief is included in the general relief granted in these extraordinary circumstances involving a federally-declared disaster area. Sometimes the IRS relief is automatic and sometimes the taxpayers need to “report in.” ((Affected taxpayers who reside or have a business outside the covered area must call the IRS disaster hotline at 866-562-5227 to request such tax relief. See https://www.benefits.gov/benefits/benefit-details/441.))
Casualty / Disaster Loss Deductions
The key provision in the Internal Revenue Code for tax relief due to casualties is Section 165 “Losses.”
Casualty losses for personal assets are an itemized deduction even though personal in nature, which is a rare exception to the general prohibition on deducting personal expenses or losses. Even the loss of a pleasure boat in a casualty yields an itemized tax deduction under current law, to the extent the loss exceeds $100 and 10% of adjusted gross income. ((See “Personal property” discussion, IRS Pub. 547 (2016), p. 9.))
Narrow exceptions: The Disaster Tax Relief and Airport and Airway Extension Act of 2017, H.R. 3823) provides an exception to benefit non-itemizers and waives the 10% of adjusted income rule for uncompensated losses arising on or after August 23, 2017 for losses related to Hurricane Harvey, or September 4, 2017 for losses related to Hurricane Irma, or September 16, 2017 for losses related to Hurricane Maria. This special relief didn’t reach the Northern California fires that occurred shortly after the hurricanes.
Note that interest expense on personal purchases is generally nondeductible. Interest expense incurred to replace a personal asset (other than interest on a personal residence) would not qualify as a deduction under the rules governing interest expense or casualties. ((Sections 163(h), 165.))
Under current law, the first portion of the casualty loss form, Form 4684, is devoted to personal use property.
Some of the recent legislative proposals look to retain only the home interest deduction and some level of charitable donations, which would eliminate the casualty loss deduction on personal assets.
Given the devastating effect of the hurricanes and given there is no such legislation close to passing as we write in September-October, 2017, it seems impossible that Congress and President Trump would retroactively repeal the itemized casualty loss deduction for losses on personal assets affected by these hurricanes.
There is considerable stress on liberalizing the current disaster loss rules. The American Institute of Certified Public Accountants has recommended to Congress ten tax law changes to grant victims of casualties more relief, such as waiving the 10% of adjusted gross income reduction of casualty losses and the $100 limitation, extending the net operating loss carryback period to five years, and eliminating the 10% medical deduction limitation when the medical problems relate to a casualty event. ((See AICPA letter of July 17, 2017, to Senator Orrin Hatch by Annette Nellen, Chair, AICPA Tax Executive Committee; file:///C:/Users/JM/AppData/Local/Microsoft/Windows/Temporary%20Internet%20Files/Content.IE5/NYHPA0II/AICPA-comments-to-SFC-individual-tax-reform-final-7-17-17.pdf.))
There is an election for personal casualty losses, as well as business and investment property casualty losses, whereby one treats the casualty as having occurred in the year prior to the actual casualty. This relief is limited to losses arising in federally declared disaster areas. ((Section 165(i).))
It isn’t possible to claim part of the deduction in a prior year and the rest in the current year; i.e., tailor the amounts to what may be the greatest advantage. ((See “FAQ for Disaster Victims, Casualty Loss and Section 165,” https://www.irs.gov/businesses/small-businesses-self-employed/faqs-for-disaster-victims-casualty-loss-valuations-and-sections-165-i; see Regs. 1.165-11T.))
It is possible that the casualty will result in a net operating loss that carries to other years for some taxpayers. ((See Regs. 1.165-7(c)’ and 1.172-3(a)(3)(iii’) re special treatment for NOL purposes of losses related to personal casualties.))
Mr. Rojas has questioned the fairness of Representative Ryan’s approach of repealing the net operating loss carryback while preserving the concept of carryovers. ((See “Net Operating Loss Carryback Repeal Isn’t Getting the Attention It Deserves,” rojascpa.com, “Articles.”)) The fairness of repealing any NOL carryback needs to be viewed in this context of catastrophic natural disasters and resulting losses. An obvious argument would be to at least contemplate some exceptions to any general repeal of carrying back net operating losses.
Current law contemplates generally a 3-year carryback rather than the normal 2-year carryback to the extent the net operating loss relates to casualties. ((Section 172(b)(1)(E)’.))
Also note the IRS reminder that “You don’t have to be in business to have an NOL from a casualty.” “Topic 515, Casualty, Disaster, and Theft Losses (including Federally Declared Disaster Areas),” https://www.irs.gov/taxtopics/tc515.html.))
“These (net operating loss) deductions must relate to a trade or business, work as an employee, or casualty or theft.” ((Part 4, Examining Process, Chapter 11. Examining Officers Guide (EOG), Section 11 Net Operating Loss Cases, https://www.irs.gov/irm/part4/irm_04-011-011.html.))
It is, of course, important to maintain accounting records and financial details.
While the IRS stresses the importance of proof, it also contemplates problems may arise with calamities.
“It is important that you have records that will prove your (casualty or theft) deduction. If you don’t have the actual records to support your deduction, you can use other satisfactory evidence to support it.” ((IRS Pub. 547 (2016), Casualties, Disasters, and Thefts.” See also IRS Pub. 584 (2012), “Casualty, Disaster, and Theft Loss Workbook. The IRS stresses keeping records that support the casualty loss deduction, and gives a Resource Guide, which includes a reference to an IRS Disaster Assistance Line; (866) 562-5227 also noted above.))
The costs of photos and appraisals of damaged property aren’t part of the casualty deduction but they can qualify as expenses incurred in determining tax liability, another itemized deduction. ((IRS Pub. 547 (2016), p. 5.))
Among the components of measuring the deduction is the asset’s net basis.
The general rule for measuring the loss is the lesser of adjusted basis prior to the casualty or the decrease in the property’s fair market value as a result of the casualty; such amount is then reduced by insurance proceeds received or that you expect to receive. ((Regs. 1.165-7.))
Disputes between the taxpayers and the IRS over hurricane damage can end up being resolved by the Tax Court judge, and can involve such esoteric concepts as buyer resistance and general apprehension as to a casualty’s recurrence as a factor of measuring the decline in fair market value. ((See Charles C. Cantrell, T. C. Memo 1978-273.))
Insurance recovery reduces the deduction, and asserting the insurance claim is required to sustain the loss deduction. ((See Sec. 165(h)(4)(E)’. See generally Regs. 1.165-1(d)(2), 1.165-7, CCA 200725031, 6/22/07, https://www.irs.gov/pub/irs-wd/0725031.pdf; Publication 547 (2016), Casualties, Disasters, and Thefts,” p. 4, https://www.irs.gov/publications/p547/.))
The costs of repairs and clean up are not part of the casualty loss but they can be used as a measure of the decrease in fair market value if sundry requirements are met, such as the repairs taking care of damage only and not increasing value beyond the value at the time of the casualty. In general, repair costs may only serve as an estimate of reduced value and then only if aimed at restoring, not enhancing, value. ((Regs. 1.165-7(a)(2)(ii); IRS Pub. 547 (2016), p. 5.))
Similarly, replacement costs aren’t necessarily indicative of the casualty loss; e.g., a personal-use chair costing $400 is replaced by a $500 chair but the casualty loss is limited to the value of the damaged charity just prior to the disaster (or its $400 basis, if less). ((IRS Pub. 547 (2016), p. 5.))
When business or investment property is completely destroyed, the concept of decline in value doesn’t apply; i.e., the loss is adjusted basis minus salvage value less reimbursements received or expected to be received. ((Regs. 1.165-7; Publication 547 (2016), Casualties, Disasters, and Thefts,” p. 4, https://www.irs.gov/pub/irs-pdf/p547.pdf.))
For personal use property and employee property, the deduction is measured and then reduced by $100 per casualty. The $100 adjustment is a single adjustment on a joint return, but applied to each spouse if married filing separately. The $100 limit generally applies to each separate owner of jointly owned property. ((Publication 547 (2016), Casualties, Disasters, and Thefts,” p. 4, https://www.irs.gov/publications/p547/.))
As noted, for personal-use and employee property, after applying the $100 rule, the deduction is further reduced by 10% of adjusted gross income. ((Publication 547 (2016), Casualties, Disasters, and Thefts,” p. 7, https://www.irs.gov/publications/p547/.)) As noted above, there is narrow relief from the 10% rule for 2017 hurricane victims.
In measuring the casualty loss on a personal residence, trees and other landscaping and the personal residence are treated as one asset. ((See “FAQ for Disaster Victims, Casualty Loss and Section 165,” https://www.irs.gov/businesses/small-businesses-self-employed/faqs-for-disaster-victims-casualty-loss-valuations-and-sections-165-i.))
In a business context, these rules basically focus on each asset; i.e., “the single, identifiable property damaged or destroyed.” ((Regs. 1.165-7(b)(2).)) Applying the concept of “single, identifiable property” can be quite problematic. For example, measuring the casualty loss at a telecommunications plant may prove to be difficult and controversial. ((See technical advice memorandum, TAM 201014052, 4/9/10.))
Mold damage that arises from the disaster is part of the casualty loss. ((See “FAQ for Disaster Victims, Casualty Loss and Section 165,” https://www.irs.gov/businesses/small-businesses-self-employed/faqs-for-disaster-victims-casualty-loss-valuations-and-sections-165-i.))
If your home or business property survived the flood in relatively good condition but the governmental authorities say the real estate needs to be demolished due to concerns of related problems, such as nearby mud slides, this is casualty loss. ((IRS Pub. 547 (2016), p. 13.)) This example would encompass such matters as levy overflow after a disaster event.
The casualty loss would apparently encompass any looting also. ((“Preliminary Thoughts on Tax Implications of Hurricane Harvey,” Gerald H. Schreiber, Jr., The CPA Journal, August 31, 2017, http://www.cpajournal.com/2017/08/31/preliminary-thoughts-tax-implications-hurricane-harvey//.))
A disaster may also have disastrous tax effects. The current version of the investment credit is rather limited but when the credit has been taken, it is recaptured if the asset is destroyed in a casualty. There is no casualty exception to mitigate the recapture. ((Section 50; see generally Sections 46-50; S. Rep. No. 92-437, 97th Cong. 1st Sess. on the Revenue Act of 1971; see “Avoiding Income Tax Recapture,” Al Ellentuck, The Tax Adviser, 4/30/13; https://www.thetaxadviser.com/issues/2013/may/casestudy-may2013.html.))
We noted insurance reimbursements reduce the loss deduction, but they occasionally raise gain and gain deferral issues. ((See generally IRS Pub. 547)).
Insurance reimbursement for destruction of your principal residence can also bring into play the general rules excluding $500,000 of gain on a principal residence ($250,000 for singles); i.e., relief isn’t limited to purposeful sales of the personal residence. ((IRS Pub. 547, p. 10.)) In the case of gains on a personal residence arising from a casualty, it may be possible to first exclude gain under the sale of principal residence concept and then defer gain as a result of reinvestment. ((Sections 121, 1033.))
Reimbursements and their tax treatment can be rather problematic at times. In general, if an employer sets up an emergency fund to help employees by reimbursing them to rehabilitate or replace property damaged in a disaster, the reimbursement reduces the employee’s casualty loss. Cash gifts from relatives and neighbors without limits on how the funds are used are generally tax free and don’t reduce the casualty loss deduction.
Living expenses reimbursed by the insurance company may be tax free when, e.g., you lose the use of your home due to casualty, although the IRS also finds income if the reimbursement of living expenses exceeds the taxpayer’s temporary increase in living expenses.
Qualified relief payments in a federally declared disaster are taxfree. ((See generally “Insurance and Other Reimbursements” discussion in IRS Pub. 547 (2016), p. 6. The following FEMA site describes government insurance; https://www.fema.gov/national-flood-insurance-program.))
In general, if your casualty loss was overstated considering reimbursements received in a later year, one makes certain calculations focused on reporting the reimbursement as income in the later year to the degree of the benefit of the deduction in the prior year. ((“FAQs for Disaster Victims – Amended Returns,” https://www.irs.gov/businesses/small-businesses-self-employed/faqs-for-disaster-victims-amended-returns. See also “FAQs for Victims of Hurricanes and Other Major Disasters,” https://www.irs.gov/businesses/small-businesses-self-employed/faqs-for-victims-of-hurricanes-and-other-major-disasters.))
In general, the definition of casualty loss is relatively narrow and focused more on property damage; i.e., it doesn’t per se encompass all the extraordinary expenses often arising in conjunction with disaster losses. So it is generally difficult to fit these within the definition of deductible expenses. On the other hand, the reimbursements of many types of disaster related expenses are often taxfree. ((See generally IRS Pub. 547 (2016), p. 14.))
The general rule is that any inflow of assets or services is income reportable on your Form 1040. For example, if you find a lost $100 bill in the bus seat next to you, the miscellaneous income line of your next return is supposed to report it. ((Section 61, Regs. 1.61-1.)) The main exception is that gifts are not subject to income tax as we noted above. ((Section 102.)) And while it isn’t impossible to have income arising as a result of a casualty, particularly when it relates to payments for loss of low-basis property, disaster relief payments from a federally declared disaster are taxfree and do not require an accounting to the IRS as being reasonable in relation to your particular circumstances. ((See generally Sec. 139, “Disaster relief payments,” which encompasses FEMA payments. One of the requirements for employer payments to be taxfree is that they are not covered by insurance. Sec. 139(b). See “Employers Helping Employees,” What’s News in Tax, Karen Field and Kelli Cacciotti, September 25, 2017, https://home.kpmg.com/content/dam/kpmg/us/pdf/2017/09/tnf-harvey-wnit-september5-2017.pdf. Their discussion includes the tax consequence of employees donating paid time off to employees affected by the casualty.) )
Inventory losses can also fall into the category of casualty losses that would qualify for this rule of deducting the loss in the year of the casualty or the prior year.
A casualty loss with respect to property being depreciated generally means the property can no longer be depreciated under the percentage tables. ((See IRS Pub. 946 (2016), “How to Depreciate Property,” file:///C:/Users/JM/AppData/Local/Microsoft/Windows/Temporary%20Internet%20Files/Content.IE5/NYHPA0II/p946.pdf.))
More on Benefits Received, Including Employer Issues
Extraordinary circumstances may translate into extraordinary payments, including extraordinary payments that may benefit the firm’s employees, all of which can raise such issues as current deductibility and/or whether payment may be taxable to employees.
The basic criteria for deducting payments in a business context are that the payments be “ordinary and necessary.” ((Section 162.)) Generally, this tax statute has been liberally interpreted to sanction deductibility of expenditures made in extraordinary circumstances.
Business expenses paid in connection with a casualty affecting the business would ordinarily be deductible. ((The following does not appear to address compensation issues when an employer takes extraordinary steps to benefit employees, but on employer related issues generally arising in casualties, see “Comprehensive FAQs for Employers on Hurricanes and Other Workplace Disasters,” Legal Alert by Fisher Phillips, https://www.fisherphillips.com/resources-alerts-comprehensive-faqs-for-employers-on-hurricanes-workplace-disasters.))
It is not uncommon for employers to provide special benefits to employees recovering from disasters. ((See generally IRS Pub. 3833, Disaster Relief: Providing Assistance Through Charitable Organizations, “Employer-Sponsored Assistance Programs,” p. 15; https://www.irs.gov/taxtopics/tc515. The discussion includes helping employees through donor advised funds. See also commentary by J.P. Morgan, “When Disaster Strikes,” https://am.jpmorgan.com/private-bank/public/gl/en/disaster-resource-center.))
IRS commentary alludes to the above and includes the following discussion in so far as excluding payments from income.
“Payments that individuals receive under a charitable organization’s program as a result of a disaster or emergency hardship are considered to be gifts and are excluded from gross income of recipients under section 102 of the Code. Payments from an employer-sponsored public charity or private foundation are also exempt from gross income so long as the requirements described in “Employer-Sponsored Assistance Programs,” …. are met.
An examination of the facts and circumstances surrounding a charity’s payment to a for-profit business will govern whether the business can exclude the amount paid from gross income as a gift under Section 102 of the Code. The IRS will evaluate whether the charity intended the payment to be a gift, and was motivated by charitable impulses. If the payment was made out of a moral or legal obligation, an anticipated economic benefit or in return for services, the payment will not be excluded from income as a gift.”
This publication notes that payments individual disaster victims receive under social programs based on need are not included in income. “In addition, certain payments that individuals receive from a state, federal or local government (or agency thereof), in connection with a qualified disaster, ……, are excluded from the gross income of the recipient under section 139 of the Code.” ((IRS Pub. 3833, p. 20.))
The following commentary of employer assistance is noteworthy, explaining why generally, even temporary housing provided by an employer is exempt.
“In some instances, a corporation or other non-exempt entity may choose to provide direct assistance to disaster victims rather than funneling its assistance through a charity or governmental entity. In addition, sometimes an employer may provide assistance through a non-exempt fund established to receive contributions from the employer as well as employees. In certain circumstances, payments from such sources may receive favorable tax treatment as well. As noted on page 14, section 139 of the Code provides for special tax treatment of qualified disaster relief payments made to victims of a qualified disaster, regardless of the source. Qualified disaster relief payments are not included in the income of recipients to the extent that any expenses covered by these payments are not otherwise compensated by insurance or other reimbursements. Qualifying payments are not subject to income tax, self-employment tax, or employment taxes (Social Security, Medicare, and federal unemployment taxes) even if the payments are made directly from an employer.
Example
A for-profit corporation makes grants to its employees who are affected by a flood that was a Presidentially-declared qualified disaster. The grants will pay or reimburse employees for medical, temporary housing, and transportation expenses they incur as a result of the flood that are not compensated by insurance or otherwise. The corporation will not require individuals to provide proof of actual expenses to receive a grant payment. The corporation’s program, however, contains requirements (which are described in the program documents) to insure that the grant amounts are reasonably expected to be commensurate with the amount of unreimbursed reasonable and necessary medical, temporary housing and transportation expenses they incur as a result of the flood that are not compensated by insurance or otherwise. The corporation will not require individuals to provide proof of actual expenses to receive a grant payment. The corporation’s program, however, contains requirements (which are described in the program documents) to insure that the grant amounts are reasonably expected to be commensurate with the amount of unreimbursed reasonable and necessary medical, temporary housing, and transportation expenses the corporation’s employees incur as a result of the flood. The grants are not intended to indemnify all flood-related losses or to reimburse nonessential, luxury, or decorative items and services. The grants are available to all employees regardless of length or type of service with the corporation.
The grants made by the employer are qualified disaster relief payments expected to be commensurate with the unreimbursed reasonable and necessary personal, living or family expenses of the employees not compensated by insurance or otherwise. The grants are excluded from the employees’ gross income under section 139.”
Real Estate Issues
Dramatic physical changes and extraordinary, unanticipated events often lead to controversies and litigation involving the interpretation of real estate contracts. It may be time to review your real estate contracts. There will undoubtedly be much litigation involving real estate and Hurricanes Harvey and Irma.
There may be dramatic reductions in values due to the physical damage and possibly even general business decline in the area during periods of recovery. In nearby areas that seem less vulnerable to the devastation, there may be the opposite effect, particularly in the long term.
Some segments of real estate can actually benefit from dramatic disasters, notably hotels and self-storage. ((“In Houston, the Fallout Begins,” Esther Fung, Wall Street Journal, August 30, 2017, p. B7.)) The effect on hotels may be an admixture of fewer visitors but greater need from locals with an influx of helpers.
Construction and repair industries may expect increased revenue due to the hurricanes.
In general, dramatic events affect value which suggests that reviews of property tax valuations may be appropriate, particularly where damage is severe, whether the property is residential, rental or business. Property tax matters turn on local laws, ordinances and practices. ((Regarding reappraisals for property in disaster areas, see “Property Taxes in Disaster Areas, Reappraisal of Property in Disaster Areas,” by the Comptroller’s Office of the State of Texas; see https://comptroller.texas.gov/taxes/resources/disaster-relief.php. You may want to confirm with counsel required disclosures of flooding to a prospective buyer. See “Seller Disclosure,” David J. Willis, http://www.lonestarlandlaw.com/Seller-Disclosure.html.))
We also note the Houston mayor has proposed a temporary rate hike in the property tax to help pay the city’s recovery expenses. ((“Mayor seeks temporary property tax hike for Harvey recovery,” Mike Morris, 9/12/17, chron.com; http://www.chron.com/news/politics/houston/article/Mayor-seeks-tax-hike-for-Harvey-recovery-12189244.php.))
Casualties often connote rebuilding which raises issues relating to refinancing, treatment of indirect costs relating to financing and related matters, including loans from related parties. Related party loans can sometimes raise tax issues, including whether they are really loans or gifts. The receipt of a loan or a gift is free of income tax to the recipient but gifts can sometimes, though rarely, raise significant gift tax issues for the donor.
Unusual circumstances can result in unusual agreements that may be subject to special tax rules that can affect the tax timing of income and expense, and sometimes even the characterization of income.
There are rules generally imputing interest income for tax purposes when loans don’t provide for interest or provide for low interest, but there are exceptions for family loans not exceeding $10,000. ((Sec. 7872(c’)(2)(A). Section 7872 also has rules governing compensation-related loans. See also Section 483.)) An accrual method taxpayer cannot accrue interest expense to certain cash-basis controlled entities or family members prior to payment. ((Sec. 267(a)(2).))
The tax rules can sometimes “reallocate” rental payments when there are unusual holiday periods in a lease arrangement, and such rules may need review when liberal agreements are made following a casualty. ((Sec. 467.))
Such rules as above are largely not focused on casualty circumstances but they may need to be considered because casualty circumstances may sometimes translate into unusual, liberal agreements.
Feasibility / Strategic Planning
In some cases, the degree of damage with its expense and revenue impact may even trigger reviews of whether it is feasible or advantageous to continue the business or portions of the enterprise.
This analysis includes such complexities as predicting the effects of the flood on the company’s customer/client base and the costs of developing a new revenue base in a new location, relocation costs, developing new employee relationships, an analysis of whether key employees can be retained if the business is relocated, etc. Relocation vs. restoration / revitalization studies may well stress the benefits of rebuilding in or near the old place of business, as well as an analysis of the level of current costs that may greatly reduce future casualty costs.
The opposite may also be true; i.e., some businesses may have circumstances that will yield major growth in sales or service revenue due to disasters.
One of the planning issues here is whether the circumstances will translate into short-term or long-term impacts on the business.
Business Reviews
Casualties translate into a myriad of planning and project needs ranging from the obvious and immediate, such as filing insurance claims and assessing work force disruptions, to the more esoteric, including assessing long-term impacts. We briefly note here some possible areas of concern.
Asset Reviews
The adverse economic impact on your customers or your debtors may raise issues of tax write offs of accounts or notes receivable, as well as physical assets.
Sundry accounting method issues may be affected by circumstances of casualty; e.g., an accrual method lender may weigh whether interest income may not be collectible due to the difficult circumstances of someone affected by the casualty.
It may generally be a good time to discuss any flooding issues with your attorney as well as your insurance agents. Disasters trigger law suits.
Disasters may impair assets to a degree that they affect the presentation in the financial statements. This is a topic you may need to discuss with your CPA.
Financing Reviews
Major changes in the group’s main area of economic work may entail basic reviews of how much equity capital and/or debt financing is required for the entity’s (group’s) cash flow needs.
Feasibility / Restructuring Reviews
In some cases, the degree of damage with its expense and revenue impact may even trigger reviews of whether it is feasible or advantageous to continue the business or portions of the enterprise.
This analysis includes such complexities as predicting the effects of the flood on the company’s customer/client base and the costs of developing a new revenue base in a new location, relocation costs, developing new employee relationships, an analysis of whether key employees can be retained if the business is relocated, etc. Relocation vs. restoration / revitalization studies may well stress the benefits of rebuilding in or near the old place of business, as well as an analysis of the level of current costs that may greatly reduce future costs.
The opposite can also be true; i.e., some businesses may have circumstances that will yield major growth in sales or service revenue due to disasters.
One of the planning issues here is whether the circumstances will translate into short-term or long-term impacts on the business.
Organizational Reviews
Casualties can create unexpected losses and issues of having unexpected tax losses that do not offset other income; e.g. losses lodging in a single corporation.
A C corporation may have to file on a stand-alone basis and may have extraordinary losses that lodge in the corporation, whereas certain corporations with a common parent connected through stock ownership may be eligible to file a consolidated return wherein one entity’s losses can generally offset income of other entities. ((Sec. 1504.))
In general, major casualty losses may trigger a wealth of planning aimed at making use of the losses from a tax standpoint. This is particularly true of groups of related entities.
State Tax Planning and Reviews
Although both Texas and Florida are well-known for not having a personal income tax, businesses will often have tax issues in these states needing review due to the dramatic changes in circumstances.
State taxation turns on measuring how much taxable income is allocable to a particular state. The details turn on the state’s particular rules governing the measurement of income and its allocation. These often involve valuations (often costs) and detailed calculations that ultimately measure how much income or loss is allocated to a particular state.
Disaster circumstances may dramatically affect other factors that affect taxable income allocations for state tax purposes, such as sales and payroll and property in a particular taxing jurisdiction.
Casualty circumstances in one state can affect the allocations of income for state tax purposes because the math is often an admixture of factors throughout the country designed to allocate combined income. State taxation rules often take this combined income allocated by factors approach versus trying to separately compute the taxable income in a state.
Dramatic changes in the factors arising in one state can significantly affect the taxes due in other states.
Helpers / Charitable Donations
Writing in November, 2017, there is the prospect of significant tax law changes soon but donations to qualified charities focused on helping disaster victims should remain deductible, even if there is a significant tax bill by year end.
Caution is necessary due to donation “scams.” ((“Beware of Fake Charity Scams Relating to Hurricane Harvey,” IR-2017-137, 8/29/17; https://www.irs.gov/newsroom/beware-of-fake-charity-scams-relating-to-hurricane-harvey.
Many charities will accept not only cash donations but gifts of listed securities. The gift of appreciated securities if held long-term (more than one year) as an investment will yield a deduction at fair market value without triggering the unrealized gain into income. ((On charitable donations generally, see IRS Pub. 526, “Charitable Contributions,” 2016.))
The nice aspect of donating listed securities is that fair market value is readily determinable, which often isn’t the case with donated property. ((See IRS Pub. 561, “Determining the Value of Donated Property. See also Form 1098-C re contributions of motor vehicles, boats and airplanes. https://www.irs.gov/forms-pubs/form-1098-c-contributions-of-motor-vehicles-boats-and-airplanes-1.))
It is permissible to claim a volunteer’s expenses (but not their time) as charitable donations when incurred in serving a qualified charity. ((See IRS Pub. 526, “Charitable Contributions, “ 2016, p. 2, 5, 12. See also IRS Pub. 3833, “Disaster Relief, Providing Assistance Through Charitable Organizations,” file:///C:/Users/JM/AppData/Local/Microsoft/Windows/Temporary%20Internet%20Files/Content.IE5/DUESXS6K/p3833.pdf.)) People just helping people, as commendable as it may be, generally doesn’t yield a tax deduction. An organized charity or governmental unit ordinarily needs to be involved for there to be a charitable deduction.
Introducing narrowly defined recipients may also translate into loss of any deduction. The IRS publication on charitable contributions expressly sanctions disaster relief but caveats: “However, you can’t deduct contributions earmarked for relief of a particular individual or family.” ((IRS Pub. 526, “Charitable Contributions, “ 2016, p. 1.)) Organized charities sometimes add a personal element by introducing the actual recipient of gifts; e.g., the orphan by name in a foreign country. Such personal touches are distinguishable and do not ordinarily destroy the deduction.
Private foundations may also be a source of help. These are basically private charities, organized, recognized charities, but subject to myriad special rules, and a special tax whose purpose is to raise funds to enable the government to monitor private foundations. Private foundations frequently entertain grants for particular causes. Private foundations may be formed by individuals or corporations, and their focus may be defined in its documents very broadly, or its charitable goals may be rather narrowly defined. For example, a private foundation might be formed with a focus of recovering from a major natural disaster, such as a hurricane. ((See “The Private Foundation as a Charitable Lifestyle,” at rojascpa.com.))
Moving Expenses
The level of damage done by the hurricanes will undoubtedly cause some to relocate.
Casualty circumstances alone do not justify an individual’s claiming a moving expense deduction.
The general test for deducting the move is commencement of employment or self-employed activities at a “new principal place of work.” ((Sec. 217(a). See generally IRS Pub. 521, “Moving Expenses,” 2016.))
The new principal place of work must generally be at least 50 miles farther from the former residence than was the former principal place of work. ((Sec. 217(c)(1)(A).))
In November, 2017, there are legislative proposals that put the moving expense deduction at some risk after 2017.
Estate, Gift and GST Taxes
There is an annual exclusion for lifetime gifts of $14,000 in 2017, and a lifetime exemption in 2017 of $5,490,000, or $10,980,000 for a married. The estate tax and GST exemptions are the same, and writing in November, 2017, there are legislative proposals for the repeal of these taxes or increased exemptions for these taxes.
The exemptions are large enough that these transfer taxes are not a significant factor for most families. Transfer tax considerations are often a major consideration for wealthier families.
If there are reductions in value due to the flooding, particularly if the reductions in value are temporary, the circumstances may warrant a review of lifetime transfers from the perspective of all of these transfer taxes.
Conclusion – The Planning Perspective
Catastrophic damages trigger a complex combination of financial matters, including cash flow and tax issues, along with the work to prove up, quantify and assert advantageously any casualty loss deductions or other relief provisions. Casualty loss deduction issues and insurance claims are often just the beginning of the financial work flowing from major disasters.
Business planning for disasters is complicated because of the multitude of people, assets and outsiders involved – employees, suppliers, creditors, lenders.
The list of considerations should include management assignments and training in the event of crisis; employee information, expertise, dispersion, back-up resources, ability to coordinate if one location is temporarily or permanently not available; computer security and back-up at multiple locations; the effect a crisis could have on major suppliers, as well as such obvious issues as insurance levels and records management. Disaster planning deserves the attention of top management and the board of directors. The list of crisis management issues and what-if scenarios is inherently complicated for a business.
The planning perspective of individuals and families may be less complicated due to the lesser numbers of people and resources involved but it may be more complicated in many ways. For example there are issues of the young and elderly, family business management in the event of crisis, concentrations of income, even different types of taxes and planning, such as estate planning. The list goes on and on and varies family by family, individual by individual.
A crisis management perspective is an important element in both personal and business planning.
