Dealing with the Tax Consequences of a Natural Disaster
When a natural disaster strikes, most taxpayers have no idea of the impact income tax laws could have on their financial condition. Obviously, most are aware they have suffered some economic loss, but they need guidance in coping with the intricacies of the Internal Revenue Code relating to disaster losses. In recent disasters, such as Hurricane Hugo and the San Francisco earthquake, many taxpayers turned to CPAs for help in keeping the tax consequences of their losses to a minimum. Since natural disasters can occur anywhere, the unusual tax issues surrounding catastrophic losses are relevant to all tax practitioners. The Internal Revenue Service showed some compassion for affected taxpayers when it responded to Hurricane Hugo and the San Francisco earthquake. Hugo struck Charleston, South Carolina, on September 21, 1989, and the earthquake hit San Francisco one month later. Each left thousands of buildings, businesses and residences damaged or destroyed. Utilities and phone service were lost for more than a week. As a result, many law and accounting firms were closed for days or weeks while debris was cleared and power and telephone service restored. From a tax standpoint, this business interruption was very inconvenient because only 25 days remained to file 1988 extended individual tax returns when Hugo struck. The IRS softened the blow for victims of both disasters by granting relief in IRS notice 89-136 for late filing of extended individual returns, late payroll tax returns and deposits and late business and estate tax returns. Future concessions are very possible for tax returns and deposits that may be due soon after a catastrophe, but taxpayers in other disaster areas are not guaranteed a waiver of penalties and definitely will not have interest waived if filing and payment deadlines occur soon after a disaster. DEALING WITH PERSONAL GAINS AND LOSSES Any of number of IRC sections can apply to disaster losses and gains. The key factor in determining the proper tax treatment is the essential character of the gain or loss. (Exhibit 1 on page 53 gives a brief summary of the most relevant sections.) Special rules are provided for taxpayers in disaster areas. The foremost rule is that losses are reduced to the extent insurance or other reimbursements will offset them. This is true even though a taxpayer suffers a loss in one tax year and does not receive insurance proceeds until the next or succeeding tax year. Many taxpayers suffering losses in the fall of 1989 were not reimbursed until 1990. However, insurance reimbursements not yet received were charged against 1989 losses. Losses on personal use property, called personal casualty losses, are subject to several limitations. First, the losses stemming from a casualty or involuntary conversion of personal assets are reduced by $100. All losses resulting from a single casualty can be combined prior to the $100 deduction. Second, the losses are matched against personal casualty gains. If the result is a net loss, the loss is an allowable deduction to the extent that it exceeds 10% of adjusted gross income (AGI). If the result is a net gain, the gain is treated as a capital gain. Personal casualty losses are allowable deductions in computing alternative minimum taxable (AMT) income. When matching personal casualty gains and losses results in a net gain, the personal casualty losses are fully deductible in computing AGI for purposes of the AMT. For example, assume a taxpayer has a personal casualty loss of $30,000 and a personal casualty gain of $50,000. AGI before casualty gains and losses is $40,000. The personal casualty loss is reduced by $100, to $29,900. This amount is fully deductible in computing AGI and offsets $29,900 of personal casualty gains. The excess personal casualty gain of $20,100 ($50,000 minus $29,900) is treated for tax purposes as a gain from the sale of a capital asset. …