Natural Disasters and Tax Consequences: Individuals and Businesses Take Note

The IRS has already noted 14 federal disasters in 2023—including tornadoes, mudslides, winter storms, severe rains, and flooding. These events have tax consequences for individuals and businesses.

It seems that natural disasters are occurring more and more frequently. Both the East Coast and West Coast have recently been devastated by storms, and some central states have been hit by tornadoes. The IRS has already noted 14 federal disasters in 2023—including tornadoes, mudslides, winter storms, severe rains, and flooding. When these events happen, they have tax consequences to individuals and businesses.

Under the Taxpayer Certainty and Disaster Tax Relief Act of 2019 (P.L. 116-94), there is an automatic 60-day extension for filing tax returns for those affected by a disaster, including individuals who reside in a disaster area, those injured or killed by the disaster, businesses that have a principal place of business in a disaster area, relief workers who provide assistance in a disaster area, or any taxpayer whose tax records necessary to meet a tax deadline are located in a disaster area (Code Sec. 7508A). Regulations clarify that the 60-day period begins at the start of the incident period (e.g., when the storm begins) and ends 60 days after the last day of the incident period (e.g., when the storm ends) (T.D. 9950, 6/11/21).

The IRS has the authority to provide additional time—up to a total of one year beyond the usual deadline—for filing income, employment, and excise tax returns, as well as for various retirement plan actions, such as taking required minimum distributions, completing rollovers, or fixing certain defects in qualified retirement plans. For example, with respect to the Arkansas tornado on March 31, 2023, the IRS extended the April 18, 2023, tax-filing deadline to July 31, 2023 (IR-2023-68); this is more than 60 days from the incident. For the winter storm and snowstorm that hit  New York on March 2 of this year, the filing deadline was extended to May 15 for those in Erie, Genesee, Niagara, St. Lawrence, and Suffolk counties (IR-2023-58). The extension also applies to making 2022 contributions to individual retirement accounts (IRAs) and health savings accounts (HSAs).

The IRS lists areas qualifying for disaster relief at www.irs.gov/uac/Tax-Relief-in-Disaster-Situations.

These extensions do not give employers more time to deposit payroll taxes. However, the IRS typically abates penalties, as long as deposits are completed by specified dates.

Here are several steps businesses and individuals can take to ensure their tax accounting appropriately accounts for a disaster:

1. Quantify the loss.  Hopefully, everyone impacted by a natural disaster will have adequate insurance to cover their property damage or loss. Typically, though, many victims find that insurance proceeds don’t make them whole. Disaster losses for individuals are tax-deductible, subject to certain adjustments, if the individuals itemize their deductions. The amount of the loss must be reduced by $100, and only the amount in excess of 10 percent of adjusted gross income (AGI) is an itemized deduction. There is currently no write-off for those who claim the standard deduction. Individuals may use safe harbor methods to figure their disaster losses (Rev. Proc. 2018-08).

Businesses may deduct their uninsured property losses. There are no reductions or thresholds for claiming these business losses.

2. Decide which year to take the loss.  A disaster loss may be claimed on a tax return for the year of the event or for the prior year (Code Sec. 165(i)). Claiming the loss for the prior year entitles a taxpayer to receive a tax refund, which can be used to help rebuild after the disaster.

To claim the loss on a prior-year return, take the loss into account if the return has not yet been filed. If the return for the prior year has already been filed, then an amended return is necessary. (An amended state income tax return may also be required.) It usually makes sense to claim a loss in the year in which a greater tax benefit results. For example, for individuals, this would be the year in which AGI is lower, so that a greater portion of the loss is deductible (i.e., more of it exceeds 10 percent of AGI).

Watch the timing for making or revoking an election with respect to a disaster loss (Rev. Proc. 2016-53). The original federal tax return or amended federal tax return must be filed on or before the date that is six months after the original due date for the taxpayer’s federal tax return for the disaster year (determined without regard to any extension of time to file). A taxpayer may revoke the election on or before the date that is 90 days after the due date for making the election.

3. Understand treatment of additional disaster relief.  Typically, under Section 102 of the Internal Revenue Code, any payment from an employer to an employee, even a “gift,” is taxed to the employee as compensation. Under Code Sec. 139, however, employers are allowed to assist employees during a federally declared disaster with “qualified disaster relief payments” that are tax-free to the employee and fully deductible to the employer.

“Qualified disaster relief payments” include payments by an employer, not compensated for by insurance or otherwise, paid to or for the benefit of its employees for reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a “qualified disaster.” Repair, rehabilitation, or replacement of contents of the employee’s personal residence must be attributable to the “qualified disaster.” These payments are not subject to any federal withholding obligations and do not need to be reported on a Form W-2 or 1099.

Further, payments from the Federal Emergency Management Agency (FEMA) or private disaster relief assistance for reasonable and necessary personal, family, living, and funeral expenses incurred as a result of a “qualified disaster” are not treated as gross income. The same is true for FEMA payments for repairs to a personal residence and replacements of contents damaged in a “qualified disaster.” Note that FEMA announced, on March 15, new guidance on a its Hazard Mitigation Assistance Program (https://www.fema.gov/grants/mitigation). Payments under this program, to provide long-term solutions that reduce the impact of disasters in the future, are tax-free.

4. Defer any gains.  A disaster certainly may result in economic losses, but it may also result in taxable gains. This occurs when insurance proceeds exceed the amount of the loss (e.g., the basis in the property that is destroyed). For example, say a business has equipment insured for $10,000, but the basis of the equipment has been fully written off. When the proceeds are recouped, there is an involuntary conversion that requires gain to be reported (Code Sec. 1033).

Tax on the gain can be deferred if there is a timely reinvestment of the proceeds in qualified replacement property. This is property similar, or related in service or use, to the old property.

The replacement period usually is limited to two years after the end of the year in which the gain is realized. However, the replacement period is extended to three years for real property held in a trade or business or for investment. And the replacement period is four years for homes that are involuntarily converted due to a federal disaster. The IRS may extend the replacement period if a request is made for more time to acquire replacement property.

5. Donate to charity.  When disasters hit, there is usually an outpouring of generosity by individuals and businesses. Donations may be made to the charities providing disaster relief, such as the American Red Cross. Such donations may be tax-deductible.

As one of the IRS’s annual Dirty Dozen Tax Scams, the IRS warns taxpayers to beware of fake charities, especially during disasters (IR-2023-57). As the IRS says, “Fake charity promoters may use emails to solicit donations or alter, or ‘spoof,’ their caller ID to make it look like a real charity is calling on the phone. They often target seniors and groups with limited English proficiency. Before making any donation to a charity, verify whether it is eligible to receive tax-deductible donations through the IRS’s tax-exempt organization search at https://www.irs.gov/charities-non-profits/tax-exempt-organization-search.

Additional Resources

Gerard Schreiber, CPA, the “Master of Disaster,” has created a helpful resource for CPAs working with clients affected by a disaster: //www.gscpa.org/Content/Files/Professional-Resources/Hurricane%20Resources/Guide.Florida.082819.pdf. This guide describes the “disaster declaration process,” tax implications of disasters, IRS filing relief, information about insurance company claims, deductibility of charitable aid given to disaster victims, what to expect after you apply for FEMA aid, debris removal guidelines, and more.

Additional disaster information is available from:

Sidney Kess, CPA-attorney, is of counsel at Kostelanetz & Fink.

From: New York Law Journal

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