February 6, 2020
A flurry of tax legislation passed at the end of 2019 as part of an omnibus spending package. You might have already heard about changes to the retirement plan rules and tax extenders that were part of this package.
However, there are some lesser-known changes that you might not know about. Specifically, the disaster-related provisions of the Taxpayer Certainty and Disaster Tax Relief Act provide valuable relief to taxpayers affected by federally declared disasters that happened between January 1, 2018, and January 19, 2020.
Personal Casualty and Theft Losses
Prior to 2018, individual taxpayers that itemized their deductions could write off their unreimbursed casualty and theft losses to the extent that the losses exceeded 10% of adjusted gross income (AGI). In addition, the deductible amount had to be reduced by a “floor” of $100 for each casualty or theft event.
For example, Bill had $100,000 in AGI for 2017. He incurred a $25,000 loss to his home due to hurricane damage in 2017, and his insurance company paid him $10,000 for repairs. So, his unreimbursed loss was $15,000 ($25,000 – $10,000).
Bill itemized deductions on his 2017 tax return. How much was he able to deduct for unreimbursed hurricane damages? His deduction was subject to the 10%-of-AGI threshold of $10,000 (10% of $100,000). He also had to subtract $100 per loss. So, in 2017, Bill claimed a $4,900 itemized deduction for the loss ($15,000 – $10,000 – $100).
Important: A special election allows taxpayers to deduct a loss on a tax return for the preceding year. If you’ve already filed your return for the preceding year, you can file an amended return to make the election and claim the deduction in the earlier year. Decisions regarding this election should be based on an evaluation of: 1) whether you need cash quickly, and 2) your overall tax situation in the casualty event year and the preceding year.
The Tax Cuts and Jobs Act (TCJA) repealed the deduction for casualties and theft losses for 2018 through 2025 — except for losses suffered in federally declared disaster areas. The special election to speed up the tax relief available to taxpayers in disaster areas remains in effect after the TCJA.
New Relief for Victims
The Taxpayer Certainty and Disaster Tax Relief Act doesn’t restore pre-TCJA law for all casualty and theft losses. However, it does provide the following seven tax breaks to victims in federally declared disaster areas, generally for 2018 through January 19, 2020:
- 10%-of-AGI threshold. The new law eliminates the usual 10%-of-AGI threshold on deducting losses from federally declared disasters. It also raises the floor for qualified disaster losses from $100 to $500.
- Itemizing vs. taking the standard deduction. Under the new law, you don’t have to itemize deductions to claim a disaster-related loss. You can write off your loss even if you claim the standard deduction for the tax year in question.
- Charitable contribution limits. The new law temporarily suspends the tax return limits for charitable contributions associated with qualified disaster relief. For instance, monetary contributions are normally limited to 60% of AGI, but this limit doesn’t apply to qualified donations in a disaster area.
- Certain tax credits. A special rule allows taxpayers in designated disaster areas to refer to the preceding tax year for purposes of determining the Earned Income Tax Credit (EITC) or the Child Tax Credit (CTC).
- Early withdrawal penalty. Generally, distributions from qualified retirement plans, such as a 401(k) or Simplified Employee Pension (SEP), are hit with a 10% tax penalty in addition to regular tax liability if made before age 59½ — unless a special exception applies. The list of exceptions is lengthy. The new law now provides another exception for qualified disaster relief distributions, though qualified hurricane distributions can’t exceed $100,000.
- Canceled home purchases. The new law permits recontributions of retirement plan withdrawals for home purchases canceled due to eligible disasters. It also provides flexibility for loans from retirement plans for qualified hurricane relief.
- Extended tax-filing deadlines. An individual with a principal place of residence within a federally designated disaster area, or any taxpayer with a principal place of business in such a disaster area, is granted an automatic 60-day extension for any tax filing. This provision acknowledges that victims probably have other concerns taking priority. The automatic filing extension applies to federal disaster areas declared after December 20, 2019, the new law’s date of enactment.
Special Break for Small Businesses
The new law also creates a special “employee retention credit” for 2018 and 2019. Essentially, a disaster-affected employer is entitled to a 40% tax credit for the first $6,000 of wages paid to an employee from a core disaster area. The maximum credit is $2,400 per worker.
The employee retention credit applies to wages paid regardless of whether services associated with those wages were actually performed. It’s treated as part of the general business credit.
For More Information
This article highlights the key tax breaks available to individuals and small businesses that have suffered losses in a federally declared disaster area. Other special rules may apply. If you’re hit with a disaster, consult with your tax advisor to maximize the benefits for your situation.