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Disaster tax considerations
Natural disasters are something we never want to face, and they can have devastating consequences for both individuals and businesses. Tax considerations are often very low on the priority list after a disaster, but there are a number of issues that taxpayers need to consider in the wake of a storm, earthquake or flood, including changes to federal and state tax filing dates, property tax valuation and reassessments, and employee compensation.
Federal tax relief
Filing deadlines may be postponed for a taxpayer affected by a federally declared disaster. The extent of relief varies depending on the severity of the disaster, and the notice of postponement must be reviewed carefully. Postponement can include:
- Filing of an income tax return
- Payment of tax
- Contribution to a retirement plan
- Filing a tax court petition or review of a tax court decision
- Filing a claim for credit or refund of any tax
- Any other acts provided by IRS guidance
While relief is generally targeted to certain affected taxpayers in disaster areas, taxpayers residing outside of a disaster area may still receive relief under certain circumstances.
Taxpayers affected by a disaster will discover that monetary relief can come from any number of sources, including insurance, the Federal Emergency Management Agency (FEMA), the U.S. Housing and Urban Development Agency, state resources and elsewhere. The source and use of such funds require careful analysis to understand the related tax implications and opportunities.
There are numerous provisions within the Internal Revenue Code that taxpayers affected by natural disasters should consider. Those include:
- Section 165: Casualty loss deductions, including the ability to claim the loss in the year preceding the disaster
- Section 1033: Involuntary conversions, including relaxed requirements for the replacement period and qualifying replacement property
- Section 199: Business interruption payments may qualify as domestic production gross receipts
- Section 263: Amounts spent to restore a unit of property may be subject to capitalization, depending on whether the taxpayer has taken a casualty loss deduction, among other considerations
State and local tax relief
State and local taxing jurisdictions address natural disasters in a number of ways. Many states will offer state and local tax filing extensions for state income taxes as well as sales and use taxes following a natural disaster. However, these extensions are not always automatic and may need to be requested by the taxpayer.
Additionally, states may offer favorable sales and use tax exemptions following a disaster under certain circumstances, such as exempting labor charges to repair damaged property. Several states offer limited disaster preparedness sales tax holidays, whereby taxpayers may purchase disaster-preparation equipment and supplies exempt from sales tax over a two- or three-day period.
Disaster-affected taxpayers should also consider that while most purchases made with FEMA or Red Cross vouchers and debit cards are not subject to sales and use tax, purchases of tobacco, alcohol and motor vehicles may not be exempt. State guidance on these issues varies, and taxpayers should review tax authority guidance in consultation with their tax advisors.
Compensation and benefits considerations
Many businesses are unaware of how natural disasters may affect employee compensation. Most payments from an employer to an employee are considered taxable compensation, but there are certain exceptions, including qualified disaster relief payments under section 139.
Section 139 allows for the exclusion of certain payments to or for the benefit of an individual when the following conditions are satisfied:
- The area is affected by a federally declared disaster
- The employee is affected by the disaster
- The amounts paid or reimbursed are for personal or living expenses, or home repair or rehabilitation expenses
- The amounts are reasonably expected to be commensurate with the expenses incurred
Section 139 payments are not subject to the Federal Insurance Contributions Act and do not have to be reported on a Form W-2. The employer does not need to receive formal substantiation of the employee’s expenses.
Other potential issues for employers to consider include:
- Treatment of employer-provided, interest-free loans to employees under section 7872 when the aggregated total loan amount is less than $10,000
- Treatment of donated or gifted personal time off (leave sharing)
- Tax implications related to certain 401k distributions or withdrawals
- Charity and general donation issues
- Disaster unemployment assistance