When a natural disaster strikes, taxpayers can find themselves and their families in ruin. They return to their neighborhoods to find homes, cars, furniture, and precious family heirlooms destroyed. Most likely, the last thing that anyone is thinking about is their taxes. However, relief could be on the way if the natural disaster is federally declared. Taxpayers then can either deduct the loss on their prior tax return or the year in which the disaster occurred. Whichever route the taxpayer chooses, it could end with receiving much-needed money and assistance through tax relief.
Generally, the Internal Revenue Service (IRS) considers a disaster loss as a loss in a federally declared disaster area. Although a disaster loss is a type of casualty loss, Congress enacted special rules that generally provide more favorable tax treatment for qualified disaster losses.
The president must officially declare an event to be a qualified disaster under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act. For example, in 2017 President Donald Trump declared Hurricane Harvey and Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, and the California wildfires to be qualified disasters under section 401 for special disaster tax relief purposes. Not all 2017 federally declared disasters were considered qualified disasters.
Under the publication 976, the IRS discusses disaster relief for specific information relating to:
Later legislation expanded the special rules and return procedures from 2016 and 2017 for losses attributable to certain major federally declared disasters that occurred in 2018 or 2019 as “qualified disaster” losses. The rules can be found in the Disaster Tax Relief and Airport and Airway Extension Act of 2017, the Tax Cuts and Jobs Act (TCJA) of 2017, the Bipartisan Budget Act of 2018, the Taxpayer Certainty and Disaster Tax Relief Act (TCDTR) of 2019, and the TCDTR of 2020. The TCDTR of 2019 and TCDTR of 2020 expanded the rules and return procedures for personal casualty losses attributed to certain major federal disasters declared in 2018, 2019, and 2020.
The IRS also expanded qualified disaster loss to include an individual’s casualty and theft loss of personal-use property attributable to a major disaster declared by the presidential declarations dated January 1, 2020, and February 25, 2021. However, to qualify under this expansion, the major disaster must have an incident period between December 28, 2019, and December 27, 2020. Further, the major disaster must have an incident period ending no later than January 26, 2021. This expansion does not include those losses attributable to any major disaster declared only because of COVID-19. Moreover, this change is not attributable to losses from California wildfires in January 2018 (which received relief in 2018).
These special rules above apply only to individuals with a U.S. income tax filing requirement with the IRS. Residents of Puerto Rico or the U.S. Virgin Islands should seek guidance from the Puerto Rico Department of Treasury or the U.S. Virgin Islands Bureau of Internal Revenue regarding the possibility of relief.
The IRS provides taxpayers with recent tax relief updates and guidance in disaster area.
To qualify and claim losses, taxpayers should include any personal casualty losses resulting from a qualified disaster on Form 4684 (see qualified disaster losses, casualty, and theft).
Typically, taxpayers claim casualty losses as an itemized deduction. However, this relief helps taxpayers who don’t itemize. Taxpayers can deduct qualified disaster losses for regular and alternative minimum tax (AMT) deductions on Schedule A.
Moreover, the deduction for causality and theft losses of personal-use property is limited. For tax years 2018 through 2025, an individual’s casualty and theft losses are deductible only to the extent they are attributable to a federally declared disaster.
Below are the new rules to qualify for the casualty losses:
Revenue Procedure 2018-08, 2018-2 I.R.B. 286, provides safe harbor methods to figure casualty and theft losses from personal-use residential property and personal belongings, including practices applicable only to losses from a federally declared disaster. To calculate the amount of casualty and theft losses, the taxpayer must determine the actual reduction in the fair market value of lost or damaged property using a competent appraisal or the actual cost of the repairs.
Under the TCJA, the federal government made modifications to the way taxpayers can claim deductions for federally declared disaster losses on their returns.
When a taxpayer has casualty losses, the claim for unreimbursed casualty losses should be submitted immediately after casualty losses occur or when discovered. However, a taxpayer who has a federally declared disaster casualty loss that happened in an area warranting public or individual assistance or both can elect to deduct the losses in the tax year before the loss occurred. For example, taxpayers could apply this rule to claim a qualified disaster loss they sustained in 2017 on their 2016 return and file their return electronically versus if they claimed the loss on their 2017 federal tax return.
Regarding the 2021 tax year, taxpayers could elect to deduct a disaster loss in 2021 on their 2020 federal tax return. In 2021, the federal tax filing deadline was May 17, 2021, and if they were filing state returns, the deadline could be later in the year, depending on the state. See Form 4684 and its instructions for return information. (When making such a decision, taxpayers should seek advice from a local tax professional.)
Taxpayers who have already filed their tax return for the year can amend the return to claim their qualified disaster loss by filing a Form 1040X. For example, to deduct the loss on a 2016 return, taxpayers had to file the amended return on or before October 15, 2018. However, taxpayers who had not filed their 2016 tax return and wanted to deduct or increase their standard deductions by their net qualified disaster loss on their 2016 tax return had to file using paper forms (either Form 1040 or Form 1040NR) and could not file electronically. The taxpayer had to indicate “Federally Declared Disaster” at the top of the return as outlined in the Form 4684 instructions. The processing of paper forms can take up to six weeks. (To calculate the net qualified loss, see Form 4684 Instructions.)
These taxpayers could file their tax return electronically if they claimed the losses on their tax year 2017 federal tax return, which was generally due April 17, 2018. Currently, the IRS accepts electronically filed Forms 1040-X. In Puerto Rico and the U.S. Virgin Islands, taxpayers who suffered disaster losses related to Hurricane Maria had until June 29, 2018, to file their 2017 U.S. tax returns. Taxpayers who needed additional time to file their 2017 return were allowed to file an extension giving them until October 15, 2018, to file.
If a taxpayer needs to amend a return, amended returns can take up to 16 weeks to process. To deduct the loss on their 2016 return, taxpayers had to file the amended return on or before October 15, 2018. The revised 2016 Instructions for Form 4684 included information regarding the election to claim a qualified disaster loss. Currently, tax year 2019, 2020, and 2021 Forms 1040 and 1040-SR are allowed to be amended electronically if the returns were originally e-filed. The amended return process has an improved commercial tax filing software. This new electronic option allows the IRS to receive amended returns faster while minimizing errors associated with manual submission. Additionally, because the new software allows users to input their data in a question-and-answer format, it simplifies the return process. It also makes it easier for the IRS to answer taxpayers’ questions. Taxpayers can still file a paper version of Form 1040-X and follow the instructions for preparing and submitting the paper form. (For more information, see www.irs.gov/forms-pubs/about-form-1040x; www.irs.gov/filing/amended-return-frequently-asked-questions; and www.irs.gov/forms-pubs/new-information-for-form-1040-x-filers.)
The TCDTR of 2019 extended certain expired tax benefits to 2018 and 2019. This legislation extended amended return benefits and disaster relief claims for 2018 and 2019 if the taxpayer qualified. Taxpayers should seek advice from a tax professional to determine the best tax year to claim their casualty losses.
Tax professionals will have opportunities to provide state tax planning to taxpayers living in more extensive jurisdictions or even small U.S. territories.
For instance, under the California Department of Tax and Fee Administration (CDTFA), California provides emergency tax or fee relief to taxpayers who have been directly affected by a disaster declared as a state of emergency, both within California and nationally. Services include an extension of tax return due dates, relief of penalty and interest, and replacement copies of records lost due to disaster.
California provides taxpayers with extensions of up to three months to file and pay taxes or fees. Taxpayers directly affected by disasters on the state’s listed counties qualify for relief. Taxpayers can request a filing extension or relief from interest and penalties by submitting a relief request through the CDTFA. Publication 252-A provides general information regarding relief requests. For more information, see the CDTFA website.
Congress, the IRS, and U.S. territories such as Puerto Rico have allocated disaster relief funds to support the taxpayers during a disaster. Under the Bipartisan Budget Act of 2018, Congress provided disaster aid funding and tax breaks that ensured government funding to aid rebuilding infrastructure and provide much-needed aid to businesses.
Tax professionals should be aware of the subtle differences between disaster and tax relief in certain states and territories to provide their clients with the best tax relief possible.
Under the tax code, payments made from an employer to an employee are considered compensation outside of certain exceptions. One of the main exceptions that could fit under disaster relief is section 139 of the tax code. Under such regulation, certain payments or reimbursements are excluded from employers to an employee if (1) the area was affected by a federally declared disaster or (2) the employee is affected by the federally declared disaster, which means the employee lives in a county declared as a qualified county.
As an advising attorney, you might have some opportunities to assist your client with tax relief. Clients fitting under the payment exceptions do not have to report income on their W-2 or 1099-MISC Form. In addition, these payments are not subject to the Federal Insurance Contributions Act (FICA). Going through a federal disaster is tough; exploring all relief options that can benefit a client is imperative, and this section could provide some relief.
Understanding and deciphering tax law can be a difficult task. Therefore, taxpayers should seek the guidance of a tax professional to guide them on their tax needs. A tax professional can help taxpayers understand the tax code and assist taxpayers with their filing needs for current year tax filing or amended return filings. Tax professionals can determine the best course of action for an affected taxpayer dealing with a disaster and the corresponding losses. Moreover, a tax professional will provide essential guidance on how to claim a disaster loss.
Taxpayers can contact the IRS with any disaster-related questions or inquiries by calling the disaster hotline and identifying themselves to the IRS agent assisting them on their disaster relief claim. The number for the hotline is 866/562-5227. If additional forms or publications are needed, there are several ways one can obtain them. They can be downloaded at www.irs.gov or ordered at no cost by calling 800/829-3676. If additional tax assistance is needed, taxpayers should call 800/829-1040. IRS personnel may be able to provide face-to-face assistance on disaster-related issues at local IRS offices. Taxpayers can find a local Taxpayer Assistance Center at www.irs.gov/help/contact-your-local-irs-office.
