Income Tax Relief in Times of Disaster
CRS Report for Congress
Income Tax Relief in Times of Disaster
Pamela J. Jackson
Analyst in Public Sector Economics
Government and Finance Division
Summary
Income tax relief in times of disaster is varied, but typically includes several key
provisions in the federal tax code. These provisions include a deduction for casualty
losses, the postponement of filing deadlines, and the abatement of interest and/or fees.
Generally, individuals and businesses can claim an income tax deduction for
casualty losses. When the casualty losses occur in a presidentially declared disaster area
special tax provisions come into play. For example, taxpayers can shorten the amount
of time it takes to receive an income tax refund by filing an amended tax return for the
previous tax year to claim losses from the disaster. Another special tax rule allows for
the deferral of capital gain from involuntary conversions of assets.
Taxpayers in a presidentially declared disaster area who receive grants from
FEMA, state programs, charitable organizations, or employers to cover medical,
transportation, or temporary housing expenses are able to exclude these grants from
taxable income.
Most recently, in response to hurricanes in the Gulf region (Katrina, Wilma, and
Rita), Congress enacted additional tax relief. H.R. 3768, the Katrina Emergency Tax
Relief Act of 2005, became P.L. 109-73 on September 23, 2005, and H.R. 4440, the
Gulf Opportunity Zone Act of 2005, became P.L. 109-135 on December 22, 2005. The
new laws expand existing tax relief for victims of the hurricanes.
This report will be updated as warranted by legislative events.
Special tax law provisions are designed to help taxpayers recover financially from
the impact of a disaster. Although recent legislative attention has focused on the
hurricanes of the fall of 2005, other disasters have included storms and floods, land and
mud slides, wildfires, and tornados. In many cases these disasters result in a presidential
declaration of disaster that affords victims special benefits and incentives to assist in the
recovery. Specifically, areas declared by the President of the United States to warrant
federal assistance as the result of a disaster are designated as presidentially declared
disaster areas. Depending on the circumstances, the IRS may grant additional time to file
returns and pay taxes. Individuals and businesses in a presidentially declared disaster area
Congressional Research Service ˜ The Library of Congress
can obtain a faster refund by claiming losses related to the disaster on the tax return for
the previous year, usually by filing an amended return.
Tax Relief for Losses
Casualty losses can result from the destruction of, or damage to, property from any
sudden, unexpected, and unusual event such as a flood, hurricane, tornado, fire,
earthquake, or even volcanic eruption. If property is destroyed, damaged, or stolen due
to a casualty, taxpayers may be entitled to an itemized tax deduction. Generally, the
deduction is limited to the casualty loss minus 10% of the taxpayer’s adjusted gross
income (AGI) and $100 per casualty event. Further, the deduction is reduced by any
reimbursement for the damaged property (such as insurance). In cases where the recovery
amount exceeds a taxpayer’s basis, a casualty gain occurs and is taxable.
The Katrina Emergency Tax Relief Act (P.L. 109-73) enacted a provision that
waives both the limitation of the deduction to 10% of the taxpayer’s adjusted gross
income and the $100 per casualty event. The waiver applies to losses that arise in the
Hurricane Katrina disaster area on or after August 25, 2005.
If property is not completely destroyed or stolen, or if it is personal-use property, the
loss is determined by first figuring the decrease in fair market value of the property as a
result of the casualty event. Then the decrease in fair market value is compared with the
adjusted basis in the property. The adjusted basis is usually the cost of the property plus
or minus certain adjustments. From the smaller of these two amounts, the taxpayer
subtracts any insurance or other reimbursement received or expected to be received. The
result is the loss from the casualty. If business or income-producing property is
completely destroyed or stolen, a decrease in fair market value is not considered. The
loss is the adjusted basis of the property, minus any salvage value and any insurance or
other reimbursement that is received or expected to be received.
Casualty losses are generally deductible only in the year the casualty occurred.
However, if a deductible loss occurs as a result of a disaster in a presidentially-declared
disaster area, taxpayers can choose to deduct that loss on the tax return for the year
immediately preceding the year of the casualty. If taxpayers have already filed a tax
return for the preceding year, the loss may be claimed in the preceding year by filing an
amended return (Form 1040X for individuals or Form 1120X for corporations). Claiming
the loss in this manner allows the issuance of a tax refund more quickly.
Postponement of Deadlines and Abatement
of Interest or Fees or Both
The IRS may postpone certain tax deadlines of taxpayers who are affected by a
presidentially declared disaster. The extensions apply to tax deadlines for filing most tax
returns, including individual income tax returns, corporation and S-corporation income
tax returns, partnership tax returns, estate and trust income tax returns, estate and gift tax
returns, exempt organization returns, employment tax returns, and certain excise tax
returns.
If the IRS postpones the due date for filing returns and for paying taxes, and
taxpayers are affected by a presidentially declared disaster area, the IRS may abate the
interest on underpaid tax that would otherwise accrue for the period of the postponement.
Taxpayers located in a presidentially declared disaster area do not have to pay interest on
taxes due for the length of any extension for filing their tax returns granted by the
Secretary of the Treasury.
Deferral of Gain on Involuntary Conversions
When personal property is involuntarily converted into cash (i.e., insurance
proceeds), it is generally taxed unless the proceeds are used to replace the destroyed
property with similar property within a specified period. There are, however, special rules
for a taxpayer’s principal residence, or any of its contents, when involuntarily converted
(damaged and replaced with insurance proceeds) as a result of a presidentially-declared
disaster. The Disaster Relief and Emergency Assistance Act (DREAA; P.L. 100-707)
included a provision that allows taxpayers to defer the recognition (i.e., taxation) of any
gain realized on an involuntary conversion of property that occurs as a result of a
presidentially-declared disaster. The gain on the involuntary conversion is deferred until
a taxable sale or exchange occurs.1
The replacement period for property involuntarily converted and located within the
presidentially-declared disaster area under DREAA is four years after the close of the first
taxable year in which any part of the gain upon conversion is realized.
A single exception to the involuntary conversion was provided for taxpayers who do
not own their residences. The rules apply to taxpayers who rent the home that serves as
their principal residence and have damaged or destroyed property.
Taxpayer Assistance at Local Disaster Recovery Centers
The Internal Revenue Service partners with tax professionals to provide assistance
to taxpayers at local disaster recovery centers that are usually established by the Federal
Emergency Management Agency (FEMA). These partners include the American Institute
of Certified Public Accountants (AICPA), the American Bar Association (ABA), the
National Association of Tax Professionals (NATP), and other organizations. Volunteer
accountants and other tax personnel will help address some of the tax issues and concerns
that victims will face by providing technical expertise to explain the laws regarding
disaster-related tax relief.
1 In the case of unscheduled personal property (property that is not specifically identified in the
insurance policy but is nonetheless insured), no gain is recognized when the taxpayer receives
insurance proceeds. There is no requirement that the proceeds replace the destroyed property.
The same treatment is not available for other insurance proceeds (i.e., proceeds for scheduled
property). However, other insurance proceeds for the principal residence or its contents may be
treated as a common pool of funds. If the common pool of funds is used to purchase any property
similar to, 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.
State disaster assistance coordinators also support the IRS effort at local disaster
recovery centers. Coordinators assist victims by distributing tax kits, advising about
reconstructing lost financial records, counseling on the determination of deductible
casualty losses, and preparing tax returns.
Disaster Relief Payments
Taxpayers in a presidentially-declared disaster area who receive grants from FEMA,
state programs, charitable organizations or employers to cover medical, transportation,
or temporary housing expenses are able to exclude these grants from taxable income.
However, unemployment assistance payments under the Disaster Relief and Emergency
Assistance Act are taxable unemployment compensation. Taxpayers may exclude from
income any amount received that is a qualified disaster relief payment.2 A qualified
disaster relief payment is an amount paid to the taxpayer
1. To reimburse or pay reasonable and necessary personal, family, living, or funeral
expenses that result from a qualified disaster;
2. To reimburse or pay reasonable and necessary expenses incurred for the repair or
rehabilitation of the taxpayer’s home or repair or replacement of its contents to the
extent it is due to a qualified disaster;
3. By a person engaged in the furnishing or sale of transportation as a common carrier
because of the death or personal physical injuries incurred as a result of a qualified
disaster; and
4. By a federal, state, or local government or agency, or instrumentality in connection
with a qualified disaster in order to promote the general welfare.
Disaster relief payments were originally excluded from income by the Victims of
Terrorism Tax Relief Act of 2001, which added a new section (Section 139) to the
Internal Revenue Code.
State and Local Responses
Aside from the federal response for tax relief, some states may enact tax relief that
is similar to federal provisions. An example would be allowing taxpayers additional time
to file returns or to make payment of taxes. States can also cancel interest and late filing
and late payment penalties that would otherwise apply to taxpayers.
Special Tax Relief Enacted for Gulf Region in 2005
The Katrina Emergency Tax Relief Act of 2005, P.L. 109-73, provides tax relief that
is intended to assist the victims of Hurricane Katrina. Some of the provisions enacted
distinguish between the “Hurricane Katrina disaster area,” which is the presidentially
declared disaster area, and the “core disaster area,” which is the portion of the disaster
2 U.S. Department of Treasury, Internal Revenue Service, Taxable and Non-Taxable Disaster
Payments/Benefits, website [http://www.irs.gov/businesses/small/article/0,,id=147166,00.html,
visited] Sept. 9, 2005.
area determined by President Bush to warrant individual or individual and public
assistance under the Stafford Act.3
The Gulf Opportunity Zone Act of 2005, P.L. 109-135, was signed into law on
December 22, 2005. The act provides tax benefits to assist in the recovery from
Hurricanes Katrina, Rita, and Wilma. Some of its provisions expand several sections of
the Katrina Emergency Tax Relief Act to apply to victims of Hurricanes Rita and Wilma.4
IRS Publications and Disaster Information Resources
The Internal Revenue Service has several publications available for taxpayers who
have experienced losses related to disasters. These documents explain the tax rules and
provide the filing forms and information that taxpayers may require.
Publication 547, Casualties, Disasters and Thefts
[ http://www.irs.gov/pub/irs-pdf/p547.pdf]
Publication 2194, Disaster Losses Kit for Individuals
[ http://www.irs.gov/pub/irs-pdf/p2194.pdf]
Publication 2194B, Disaster Losses Kit for Businesses
[ http://www.irs.gov/pub/irs-pdf/p2194b.pdf]
Publication 3833, Disaster Relief: Providing Assistance through Charitable Organizations
[ http://www.irs.gov/pub/irs-pdf/p3833.pdf]
Publication 559, Survivors, Executors, and Administrators
[ http://www.irs.gov/pub/irs-pdf/p559.pdf]
The toll-free IRS disaster help line is (866) 562-5227.
3 See CRS Report RS22269, Katrina Emergency Tax Relief Act of 2005, by Erika Lunder for
more detailed information.
4 See CRS Report RS22344, The Gulf Opportunity Zone Act of 2005, by Erika Lunder for more
detailed information.