Sander & Associates, P.A.

Although it is now agreed that The Federal Emergency Management Agency reacted too slowly in New Orleans, the IRS has been quick to act to ease the fears and burdens of folks whose lives have been interrupted by this Gulf Coast disaster. Congress drafted major relief legislation, the Katrina Emergency Relief Act of 2005, within three weeks of the event, and the Gulf Opportunity Zone Act of 2005 added relief for the victims of hurricanes Rita and Wilma.

HURRICANE VICTIM RELIEF AVAILABLE 

Relief for Individuals and Businesses Affected By Hurricanes

• Families will not lose tax benefits due to temporary relocations. A prolonged change in a family's living situation could affect eligibility for various tax benefits. The Acts allow individuals the option of using their 2004 income to calculate the child credit and the Earned Income Credit on their 2005 tax returns. This special rule applies to individuals who, as of the hurricane dates, lived in areas eligible for individual assistance from the federal government as a result of the disaster. The Act also grants the Treasury Department authority to allow taxpayers to retain dependency exemptions or child credits for 2005 without regard to temporary relocation.

• Families will not be taxed on forgiven debt. Discharge of indebtedness is generally treated as taxable income. Individuals affected by the hurricanes will not be taxed on personal debt relief, such as cancellation of a mortgage, granted to them before 2007.

• Tax relief is provided to individuals who provide housing assistance to dislocated persons. The Acts creates a special tax deduction for individuals who provide rent-free housing to dislocated persons for at least 60 days. The deduction is $500 for each dislocated person housed in the individual's principal residence, up to a maximum of $2,000. The deduction can be claimed in either 2005 or 2006, but cannot be claimed in both years for the same dislocated person.

• Personal casualty losses will be fully deductible. Individuals who itemize deductions have generally been allowed to deduct personal casualty losses that exceed both 10 percent of adjusted gross income and $100. The Acts waive the 10-percent and $100 thresholds, allowing individuals affected by the hurricanes to deduct the full amount of their unreimbursed losses.

• 10-percent tax on early distributions from IRAs and pensions will be waived for individuals affected by the hurricanes. Distributions from IRAs and pensions are generally subject to a 10-percent penalty if they are made before a qualifying age. To ease the financial burden faced by many families in the disaster areas, the Acts allow eligible individuals to withdraw a maximum of $100,000 from their IRAs and pensions without paying the 10-percent penalty. Individuals eligible for the waiver may pay income tax on the distribution over three years, or distributed amounts can be repaid to the IRA or pension plan over the three-year period following the distribution and receive rollover treatment. The Acts also increase the limit on loans from pension plans to eligible individuals from $50,000 to $100,000.

• The Work Opportunity Tax Credit will be extended and expanded. Employers are allowed to claim the Work Opportunity Tax Credit (WOTC) if they hire individuals from certain target groups who are considered to face barriers to employment. The credit is 40% of the first $6,000 of wages paid to the employee in the first year, up to a maximum credit of $2,400 per eligible worker. The Acts allow employers in the disaster areas to claim the WOTC for two years if they hire individuals who lived in the disaster areas prior to the hurricanes.

• The time to replace damaged property without incurring tax will be extended. Insurance proceeds are generally not taxable if they are invested in replacement property within two years (for damaged business property) or four years (for damaged principal residences in Presidentially-declared disaster areas). The Acts increase the reinvestment period to five years when replacement property is located within the disaster area.

• The availability of below-market mortgages in the disaster areas will be expanded. State and local governments may issue mortgage revenue bonds (MRBs) to finance low-interest rate mortgages for first-time homebuyers who meet certain income and purchase price limits. The Acts waive the first-time homebuyer requirement so that individuals whose homes were damaged by the hurricanes can qualify for these low-interest rate mortgages through 2007.

INCENTIVES FOR CHARITABLE DONATIONS RELATED TO HURRICANES
• Encourages cash donations by individuals. In general, individual deductions for charitable donations are limited to 50 percent of their adjusted gross income, and may be phased-out entirely if adjusted gross income exceeds certain levels. Under the Acts, cash donations related to Hurricane Katrina and made before 2006 are exempt from the 50-percent income limitation and the phaseout.

• Encourages cash donations by corporations. Corporations may deduct charitable donations up to 10 percent of their taxable income. The Acts waive the 10-percent income limitation for cash donations related to hurricane relief and made before January 2006.

• Increases the mileage reimbursement rate for charitable donation deductions. Individuals may claim a tax deduction for costs associated with using a personal vehicle for charitable work. The deduction is calculated by using a mileage reimbursement rate of 14 cents-per-gallon. The reimbursement rate for business use is updated periodically and is currently 44.5 cents-per-mile. The Acts set the mileage reimbursement rate for charitable miles at 70 percent of the standard business mileage rate, or 32 cents.

TAX FREE REINVESMENT OF INSURANCE PROCEEDS
The tax law already contained two significant tax breaks allowing a taxpayer to avoid recognizing gain from the receipt of insurance proceeds to compensate for loss of property in a casualty or disaster.

The first allows non-recognition of gain from an involuntary conversion if the property destroyed by a casualty is replaced with property similar or related in service or use. If this special rule applies, gain is recognized only to the extent that the proceeds of the conversion exceed the amount used to purchase the replacement property. Note that any tangible property acquired and held for productive use in a business is treated as similar or related in service or use to property that:

(1) Was held for investment or for productive use in a business, and

(2) Was involuntarily converted as a result of a Presidentially declared disaster,

The second applies special rules when a taxpayer's principal residence or any of its contents is compulsorily or involuntarily converted as a result of a Presidentially declared disaster:

(1) No gain is recognized by reason of the receipt of insurance proceeds for personal property that was part of the contents of the taxpayer's principal residence and not scheduled property for purposes of such insurance.

(2) All other insurance proceeds received for damage to the residence or its contents may be treated as a common pool of funds. If this pool of funds is used to purchase any property similar or related in service or use to the converted residence or its contents, the taxpayer may elect to recognize gain only to the extent that the amount of the pool of funds exceeds the cost of the replacement property. The applicable period for the replacement of involuntarily converted property is extended from two years to four years (five years for victims of the hurricanes) after the close of the first taxable year in which any part of the gain from the conversion is realized.

SPECIAL RULE FOR DEDUCTION OF CASUALTY LOSSES IN PRESIDENTIALLY DECLARED DISASTER AREA
Casualty losses are ordinarily deductible in the year the casualty occurs. However, the law permits a taxpayer to elect to deduct casualty losses caused by certain disasters either in the year of occurrence or the immediately preceding year. To qualify for the election, a loss must be caused by a disaster in an area designated by the President to be an area in need of federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

The election to deduct a disaster loss in the preceding year is made by filing a return, an amended return, or a refund claim that clearly shows that the election is being made. A signed statement must include the date of the disaster, location of the property lost, and a clearly worded election. The election must be filed no later than the due date of the return (without extensions) for the year in which the disaster occurred, or the due date of the return for the immediately preceding year (including extensions), whichever is later.

IRS PUBLICATIONS
The IRS already had, in print, a number of publications relating to tax issues that typically follow a disaster. These have been in high demand by taxpayers in Florida and Alabama who suffered losses in Hurricane Dennis, and by taxpayers in Wyoming who suffered heavy losses to 2005 Spring tornados:

- Publication 547, Casualties, Disasters and Thefts — explains how to calculate and claim a disaster loss;
- Publication 2194, Disaster Losses Kit for Individuals – a 100 page guide that contains IRS publications, forms, and instructions needed to claim losses of an individual following a disaster;
- Publication 2194B, Disaster Losses Kit for Businesses – 78 pages of IRS publications, forms, and instructions related to claiming disaster losses of a business; and
- Publication 3833, Disaster Relief: Providing Assistance through Charitable Organizations — explains how the public can use charitable organizations to help victims of disasters, and how new organizations may obtain tax-exempt status.

TAX TREATMENT OF DISASTER GRANTS
Special rules governing the taxability of FEMA disaster mitigation grants were finalized only weeks before Katrina and her sisters began churning through the lives of gulf coast residents.

On April 13 and 14, 2005, both houses of Congress passed, and the President signed shortly thereafter, H.R. 1134 to establish that disaster mitigation grants received by individuals and businesses from the Federal Emergency Management Agency would not be taxable.

SPECIFIC RELIEF FOR LATE FILING AND LATE PAYMENT
A series of 8 Information releases (so far) contains explanations of IRS administrative relief provisions:

- IR-2005-84 — Relief for 31 parishes in Louisiana, 15 counties in Mississippi and three counties in Alabama struck by Hurricane Katrina.
- IR-2005-89 — IRS Waives Diesel Fuel Penalty
- IR-2005-91 — IRS Expands Relief to Parts of Florida, Other Affected Areas
- IR-2005-95 — IRS Allows Highway Vehicle Removal of Aviation Fuel Due to Hurricane Katrina
- IR-2005-96 — Katrina Victims Will Have Until Jan. 3 to File and Pay Taxes
- IR-2005-97 — Special Relief to Encourage Leave-Donation Programs for Victims of Hurricane Katrina
- IR-2005-98 — Extra Time Granted for Tax-Exempt Bond Issuers Affected By Katrina

IRS SPECIAL HELP HOTLINE
People affected by the hurricanes who need help with tax matters can call 1-866-562-5227. Taxpayers can call the special number Monday through Friday from 7:00 am to 10:00 pm local time. Callers to this dedicated telephone line can find out about available tax relief, get free copies of their tax return transcripts and receive Disaster Tax Loss Kits. Callers may also be referred to the Federal Emergency Management Agency's assistance lines for additional help. Of course, that might take some time, and be a little confusing. You might prefer to let us handle the questions for you.

CONCLUSION
No doubt there will be more special rules and relief provisions announced by the IRS in the weeks to come. The Acts require action by the IRS to implement some of their provisions, and there is strong likelihood that initial relief from filing deadlines and other rules will be extended as the full magnitude of the events becomes known. We are following IRS announcements closely, and have access to a special web page established by the IRS for the purpose of communicating such news to us.

If you are concerned about the tax treatment of a hurricane related loss, or you require assistance to prepare and submit any claim or other paperwork to your insurance company or FEMA, please call. We know the law and we know about all the special concessions announced by various federal agencies, including the IRS. We may even be able to secure a refund of your 2004 income taxes paid, if quick action is taken.