Katrina Emergency Tax Relief Act of 2005
Katrina Emergency Tax Relief Act of 2005
Erika Lunder
Legislative Attorney
American Law Division
Summary
On September 23, 2005, President Bush signed the Katrina Emergency Tax Relief
Act of 2005 (KETRA; H.R. 3768) into law, P.L. 109-73. It primarily contains
temporary tax relief intended to directly and indirectly assist individuals in recovering
from Hurricane Katrina. The provisions cover a variety of areas, including work credits,
charitable giving, and casualty losses. This report summarizes the act.
The Katrina Emergency Tax Relief Act of 2005, P.L. 109-73, provides tax relief that1
is intended to assist the victims of Hurricane Katrina. Some of its provisions 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 area
determined by President Bush to warrant individual or individual and public assistance
under the Stafford Act.
Title I — Use of Retirement Funds for Hurricane Katrina Relief
Section 101 waives the 10% penalty tax that would otherwise apply on an early2
withdrawal from a retirement plan if the individual’s principal place of abode on August
28, 2005, was in the Hurricane Katrina disaster area and the individual sustained an
economic loss due to the Hurricane. The section applies to distributions made between
August 24, 2005, and January 1, 2007, and the maximum amount that be withdrawn
without penalty is $100,000. The funds may be re-contributed to a qualified plan over a
three-year period and receive tax-free rollover treatment. Additionally, with respect to the
taxable portion of the distribution, the individual may include one third of such amount
in his or her income for three years rather than the entire amount in the year of
distribution.
1 Section 501 is the act’s sole provision that does not deal with tax relief. It designates any part
of the act that has an effect on receipts, budget authority, or outlays to be an emergency
requirement pursuant to section 402 of H.Con.Res. 95.
2 IRC § 72(t).
Section 102 allows individuals to re-contribute, without tax consequences,
distributions that were made between February 28, 2005, and August 29, 2005, to
purchase or construct a principal residence in the Hurricane Katrina disaster area and were
not used because of the Hurricane. The contributions must be made between August 24,
Section 103 increases the amount that Hurricane Katrina victims may borrow from
their retirement plans without immediate tax consequences.3 The provision applies to
individuals whose principal place of abode on August 28, 2005, was in the Hurricane
Katrina disaster area and who sustained an economic loss due to the Hurricane. Under
current law, the maximum amount that may be borrowed without being treated as a
taxable distribution is the lesser of (a) $50,000, reduced by certain outstanding loans or
(b) the greater of $10,000 or 50% of the present value of the employee’s nonforfeitable
accrued benefits. For loans made between September 23, 2005, and January 1, 2007, the
act increases this to the lesser of (1) $100,000, reduced by certain outstanding loans, or
(2) the greater of $10,000 or 100% of the present value of the employee’s nonforfeitable
accrued benefits. The section also extends repayment due dates by one year if the original
date fell between August 24, 2005, and January 1, 2007.
Section 104 contains transition rules for plans adopting these new provisions.
Title II — Employment Relief
Work opportunity tax credit. Under IRC § 51, businesses that hire individuals
from groups with high unemployment rates or special employment needs, such as high-
risk youths and veterans, may claim the work opportunity tax credit. The credit may be
claimed for the wages of up to $6,000 that were paid during the employee’s first year. For
an employee who worked at least 400 hours, the credit equals 40% of his or her wages —
thus, the maximum credit is $2400. For an employee who worked between 120 and 400
hours, the credit equals 25% of his or her wages. The credit does not apply to wages paid
after December 31, 2005.
Section 201 allows the work opportunity credit to be claimed for wages of Hurricane
Katrina employees. Eligible employees are individuals who had a principal place of
abode in the core disaster area on August 28, 2005, and either (1) are hired during the 2-
year period beginning on that date for a position in the area or (2) were displaced by the
Hurricane and are hired between August 27, 2005, and January 1, 2006.
Retention credit. For employers with an active business that was rendered
inoperable due to damage from Hurricane Katrina for any day between August 28, 2005,
and January 1, 2006, section 202 provides a new credit for continuing to pay their
employees’ wages. The credit is equal to 40% of the wages, limited to $6,000, of each
employee whose principal place of employment with the employer on August 28, 2005,
was in the core disaster area. It applies to wages paid between the date the business
became inoperable at the employee’s principal place of employment and the date it
resumed significant operations there, but no later than December 31, 2005. It may not be
3 IRC § 72(p).
claimed by an employer with more than 200 employees or one who claims a work
opportunity credit for the wages.
Title III — Charitable Giving Incentives
Limits on charitable deductions. Under IRC § 170, individuals may not claim
a charitable deduction that exceeds 50% of their “contribution base” (adjusted gross
income with certain adjustments) and corporations may not claim a deduction that
exceeds 10% of their taxable income with certain adjustments. Any excess contributions
may be carried forward for five years. Section 301 suspends the 50% and 10% limitations
for cash contributions made between August 27, 2005, and January 1, 2006. For
individuals, the deduction may not exceed the amount that the taxpayer’s contribution
base exceeds his or her other charitable contributions. For corporations, the deduction is
allowed only for contributions used for Hurricane Katrina relief efforts and may not
exceed the amount that the corporation’s taxable income exceeds its other contributions.
The act also suspends the overall limitation on itemized deductions for individuals.
Housing exemption. Section 302 of the bill allows individuals who provide free
housing for at least 60 consecutive days to persons displaced by Hurricane Katrina to
claim personal exemptions for those persons. The exemption is $500 per person, with a
maximum of four exemptions per year. They are available in 2005 and 2006, although
a taxpayer may claim a person only once. The taxpayer must include on his or her return
the displaced person’s taxpayer identification number. In order to qualify, the displaced
person must have had a principal place of abode on August 28, 2005, in the Hurricane
Katrina disaster area. If the home was not in the core disaster area, then either the home
had to have been damaged by the Hurricane or the person was evacuated due to it.
Mileage rate for charitable contribution deduction. Individuals who use
their personal vehicles for charitable purposes may claim a deduction based on the
number of miles driven. The statutory amount is 14 cents per mile.4 Section 303 sets the
rate at 70% of the standard business mileage rate (rounded to the next highest cent) if the
vehicle is used for Hurricane Katrina relief between August 24, 2005, and January 1,
2007. The standard business mileage rate is periodically set by the IRS and is currently
Mileage reimbursement.Section 304 excludes from a charitable volunteer’s
gross income any qualifying mileage reimbursements received from the charitable
organization for the operating expenses of the volunteer’s passenger automobile. The
expenses must arise from using the vehicle for Hurricane Katrina relief between August
Inventory. In general, donors of food inventory who are not C corporations may
only claim a charitable deduction that equals their basis in the inventory (typically, its5
cost). C corporations may deduct the lesser of (1) the basis plus 50% of the property’s
appreciated value or (2) two times basis. Section 305 allows all donors of wholesome
4 IRC § 170(i).
5 IRC § 170(e).
food inventory to benefit from this enhanced deduction if the donation is made between
August 28, 2005, and January 1, 2006. Donors who are not C corporations may not
compute the deduction using contributions in excess of 10% of their net business income.
Section 306 allows C corporations to claim an enhanced deduction for donations of
book inventory to public schools if made between August 27, 2005, and January 1, 2006.
The corporation may deduct the lesser of (1) the basis plus 50% of the property’s
appreciated value or (2) two times basis. The school must certify that the books are
suitable and will be used in its educational program.
Title IV — Additional Tax Relief Provisions
Discharge of indebtedness. When all or part of a debt is forgiven, the amount
of the cancellation is ordinarily included in the income of the taxpayer receiving the
benefit of the discharge.6 There are currently several exceptions to the general rule that
a cancelled debt is included in taxable income in the year of discharge. For example, no
amount of the discharge is included in income if the cancellation is intended to be a gift7
or is from the discharge of student loans for the performance of qualifying services.
There are also certain situations in which the taxpayer may defer taxation, with the
possibility of permanent exclusion, on income from the discharge of indebtedness, such
as if discharge occurs when the debtor is in title 11 bankruptcy proceedings or insolvent.8
Section 401 allows victims of Hurricane Katrina to exclude non-business debt that
was forgiven by a governmental agency or certain financial institutions if the discharge
occurred between August 24, 2005, and January 1, 2007. Individuals are eligible for this
benefit if their principal place of abode on August 25, 2005, was in the core disaster area
or if it was in the Hurricane Katrina disaster area and they suffered an economic loss due
to the Hurricane. The exclusion does not apply if the real property that secured the debt
was located outside of the Hurricane Katrina disaster area.9 Individuals with certain tax
attributes (such as basis) would be required to reduce them by the amount excluded from
income, which has the effect of deferring the tax on the cancelled debt.
Casualty losses. There are several circumstances under which taxpayers may
deduct losses of property not connected to a trade or business, including when the losses
are from a casualty, such as a hurricane.10 In addition to losses from the actual damage
caused by the casualty, a taxpayer in a presidentially declared disaster area has a casualty
loss if ordered, within 120 days of the area’s designation, by the state to demolish or
relocate his or her home because it is unsafe due to the disaster. The amount of the loss
is the lesser of (1) the decrease in the property’s fair market value due to the casualty or
(2) the taxpayer’s adjusted basis in the property (i.e., the cost of the property with certain
6 IRC § 61(a)(12).
7 IRC §§ 102 and 108.
8 IRC § 108(a).
9 The heading of section 401(c)(2) refers to “[r]eal property outside core disaster are,” while the
section’s language refers to real property located outside of the Hurricane Katrina disaster area.
10 IRC § 165.
adjustments). The cost of repairing the property may be used as evidence of the amount
of loss.11 There is no loss if the taxpayer is reimbursed by insurance or other means. The
taxpayer may only claim a deduction to the extent that the loss from the casualty exceeds
(1) $100 plus (2) the sum of 10% of the taxpayer’s adjusted gross income and any taxable
gains from property that was involuntarily converted due to a casualty (discussed above).
In general, the deduction may only be claimed in the year of the loss, although a loss in
a presidentially declared disaster zone may be deducted in the year prior to the loss.
Section 402 waives the $100 and 10% floors for casualty losses from Hurricane
Katrina.
IRS Authority to suspend tax-related deadlines. Under IRC §§ 7508 and
including those affected by a presidentially declared disaster.12 These deadlines include
those for filing returns and making payments for income, gift, and estate taxes. Income
taxes withheld at source and employment taxes are explicitly excluded, and excise taxes13
are not mentioned. Section 403 gives the IRS the authority to postpone deadlines related
to employment and excise taxes. Additionally, while the IRS announced in News Release
IR-2005-96 that it would extend deadlines for Hurricane Katrina victims until January 3,
Mortgage revenue bonds. Mortgage revenue bonds are tax-exempt bonds used
to finance below-market rate mortgages for low and moderate-income homebuyers who
have not owned a home for the past three years.14 Homes in targeted areas, which are
areas that are low-income or of chronic economic distress, are subject to special rules that,
among other things, remove the requirement that the homebuyer not have owned a home
for the past three years. Section 404 similarly removes the three-year requirement if the
home is in the core disaster area or if it is a replacement residence for an individual whose
original residence in the Hurricane Katrina disaster area was made uninhabitable by the
Hurricane. The provision applies to financing provided before January 1, 2007. The
section also increases the limitation on qualified home improvement loans from $15,000
to $150,000 for loans used to repair damage from the Hurricane.
Involuntary conversions. An involuntary conversion occurs when property is
converted to money or other property because of its complete or partial destruction, theft,15
seizure or condemnation, or if it is disposed of under threat of condemnation. An
example of an involuntary conversion is when an individual receives an insurance
payment for damaged property. If the cash or property that was received is worth less
than the basis of the property that was converted, the taxpayer has a loss, which may
qualify for deduction under the casualty loss rules discussed below. If the cash or
11 26 CFR § 1.65-7(a)(2)(ii).
12 The actual authority to postpone the deadlines is granted to the Secretary of the Treasury. For
information on IRS administrative actions after Hurricane Katrina, see CRS Report RS22261,
Hurricane Katrina: The Response by the Internal Revenue Service, by Erika Lunder.
13 IRC §§ 7508(a)(1)(A) and (B).
14 IRC § 143.
15 IRC § 1033.
property received is worth more than the basis of the property that was converted, then
the taxpayer has a gain, which may or may not be immediately taxable.
There are no immediate tax consequences if the property is converted to property that
is similar or related in service or use (“similar property”).16 If, on the other hand, the
property is involuntarily converted to cash or dissimilar property, the taxpayer must
recognize any gain unless he or she purchases similar property within a certain time
period. If the taxpayer purchases the replacement property in a timely manner, then he
or she may elect to only recognize gain to the extent that the amount realized from the
involuntary conversion exceeds the cost of the new property. The time period is generally
two years. It is increased to three years if the converted property is business real property
and to four years if the property is the taxpayer’s principal residence or its contents which
were involuntarily converted due to a presidentially-declared disaster.17 Additionally, the
IRS has the discretion to extend the time period on a case-by-case basis.
Section 405 increases the time period to purchase the replacement property to five
years. The extended period applies for property in the Hurricane Katrina disaster area that
was converted due to the Hurricane so long as substantially all of the use of the
replacement property occurs in the disaster area.
Credit computations. Section 406 allows Hurricane Katrina victims to elect to
use last year’s earned income for computing the child tax credit [IRC § 24] and the earned
income tax credit [IRC § 32] instead of this year’s income. It applies to individuals
whose principal place of abode on August 25, 2005, was in the core disaster area or was
in the Hurricane Katrina disaster area and who were displaced by the Hurricane.
Authority to make adjustments relating to status. Section 407 allows the
Treasury Secretary to make adjustments in the application of the tax laws for tax years
2005 and 2006 so that temporary relocations due to Hurricane Katrina or the receipt of
relief does not cause taxpayers to lose dependency exemptions or child credits or to have
a change of filing status.
16 The taxpayer’s basis in the new property is the same as in the converted property; thus, he or
she is able to defer recognition of any gain until he or she sells or exchanges the new property.
17 When a taxpayer’s principal residence or its contents are involuntarily converted due to a
presidentially-declared disaster, he or she does not recognize any gain upon receiving insurance
proceeds covering unscheduled personal property located in the residence. The other insurance
proceeds, including amounts received for the residence and scheduled items, are combined into
a common pool of funds. The taxpayer has four years to use any of the pooled funds to purchase
replacement property for the residence or its content in order to take advantage of the non-
recognition rules. IRC § 1033(h).