Knowing tax rules can help you make the most of misfortune.
Floods in the Midwest. Hurricanes on the Gulf Coast. Wildfires in the West. Natural disasters like these can dismantle facilities, ruin infrastructure, disrupt production and swallow profits. They also raise common questions:
- Are disaster-related losses tax deductible?
- What rules apply to tax deductions for disaster-related expenses and losses?
- Who benefits when a region is officially declared a disaster area?
The aftermath of a disaster can seem overwhelming, but you can minimize the damage by having detailed knowledge of your insurance coverage, developing an informed tax strategy and maintaining a good working relationship with your state legislators, government officials and local taxing authorities.
Know your insurance coverage
When a business considers the tax implications of a disaster, it is primarily concerned with losses of property or property value, called casualties. As defined by IRS Publication 547, a casualty is the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected or unusual. Deductible casualty losses can result from a number of different causes, including car accidents, earthquakes, fires, floods, storms (including hurricanes and tornadoes), terrorist attacks, vandalism and volcanic eruptions.
The rules set forth by the IRS are complex and designed to limit your casualty-loss deduction. And since these rules take insurance proceeds into account when calculating your deduction, you and your company may be better off by shoring up your insurance coverage than relying on tax refunds to cover your losses.
Develop an informed tax strategy
Your tax strategy in the aftermath of a disaster should be based on federal, state and local tax rules and the guidance of your professional tax advisor. Various tax strategies can be utilized, including, but not limited to, property tax valuation, casualty loss deductions and sales and use tax and cost segregation of reconstruction and/or repairs.
Determining deductibility. Casualty loss is not deductible if the damage or destruction is caused by:
- Accidental breakage under normal conditions
- A fire willfully set by you or someone acting for you
- A car accident, if your willful negligence or action (or that of someone acting for you) caused it
- Progressive deterioration-the damage resulting from a steadily operating cause or a normal process, rather than from a sudden event.
The IRS does not allow businesses to take deductions on the loss of future earnings due to a disaster either. The reasoning is that if Company X loses profitability, its tax burden falls along with the drop in its taxable earnings.
In light of recent floods, tornados and other natural disasters that some areas have experienced, many companies are concerned about the tax implications of assisting their employees. As a general rule, any payment from an employer to an employee is presumed to be compensation. The Supreme Court shares this view, holding that companies do not typically make gifts to employees out of disinterested generosity.
If a payment to an individual is neither compensation nor a loan, then it is considered to be a gift, which is nondeductible for income tax purposes for the company making the gift and subject to gift tax reporting rules and possibly gift tax. Gifts to charities, on the other hand, are deductible for both income tax purposes and gift tax purposes.
There are new rules related to payments to an employer disaster relief fund. If the fund meets IRS requirements, the contributions to the fund may be allowed as a tax deduction on the company's tax return. The fund typically serves a single, identified, charitable purpose, which is to provide relief from one or more qualified disasters. While these rules are relatively complex, the establishment of such a fund could achieve the company goals of assisting an affected employee or group of employees in a tax-efficient manner.
There are special IRS rules related to payments made to individuals in a presidentially-declared disaster area. These rules are typically related to payments made by a state or federal agency. Contact your tax advisor for more information related to employer disaster relief funds. iBi
