Hurricane Irene, which tormented the East Coast as summer was coming to a close, was the latest storm in a record year for natural disasters. The Federal Emergency Management Agency has issued a total of 77 disaster declarations this year, 11 of which were related to the damage caused by Irene. Although the full extent of the economic carnage is still being tallied, Irene is estimated to be a billion-dollar weather event — the 10th billion-dollar natural disaster this year.
Given that much of the East Coast was declared a federal disaster area by President Obama, this designation creates opportunity for special tax treatment. In the discussion that follows, we’ll highlight some of these tax-related provisions with a focus on business taxpayers. The IRS also publishes a with IRS publications that provide information and instructions for businesses and business owners.
Postponements Related to the Storm
Once an area is declared a disaster area, the IRS is permitted to postpone certain deadlines and grant relief to taxpayers whose principal place of business is located in the covered disaster area. In the case of Irene, if your principal place of business (or the location of your business records needed to prepare an accurate return) is located in one of the designated disaster counties, the IRS has extended your filing deadline to October 31, 2011 (for corporate income tax returns with extended due dates between August 26, 2011 and October 31, 2011). This included the estimated tax payment for the third quarter that was otherwise due on September 15 for calendar-year taxpayers. In addition, if the business of your tax preparer was located in one of the identified disaster areas, the extended due date of your September 15 filings is extended to September 22, 2011. The American Institute of CPAs gives additional details on its webpage IRS Postponements Related to Hurricane Irene. For information on the impacts on state tax filings, please go to your state taxing authority website — the attached AICPA chart has links to the different state tax authorities.
Disaster Loss Deduction — Acceleration Opportunity under Section 165(i)
Casualty losses generally must be deducted in the year the casualty occurs. However, under IRC Section 165(i), taxpayers (including individuals, trusts, estates, partnerships, associations or corporations) may elect to deduct disaster area losses in the year preceding the loss year (see A&M Tax Advisor Weekly). Thus, 2011 disaster losses may be deducted in either your 2011 or 2010 income tax return. This choice gives taxpayers an opportunity to obtain tax refunds more quickly. With the rapid infusion of cash, a damaged community is better equipped to embark on the rebuilding process.
Although the possibility of a quick tax refund is attractive for taxpayers suffering the cash demands of disaster recovery, the decision to make a Section 165(i) election to deduct a disaster loss in the year preceding the loss year requires careful analysis, as articulated in our 2005 article (the genesis being the infamous Hurricane Katrina). Without this analysis, a Section 165(i) election may result in a greater total tax than if the election had not been made. Consideration should be given to the impact that the accelerated disaster loss deduction would have on the determination of your company’s tax attributes (e.g. tax credits, carrybacks, alternative minimum tax, domestic production activity deduction, etc.).
Comments in our earlier article about considering qualifying specified loss liabilities (SLLs) under 172(f) still hold today and are worth repeating here. If taxpayers do not have an income tax liability in 2010, then they should carefully consider the impact in a carryback year. Because of bonus depreciation as well as a sputtering economy in recent years, many taxpayers are finding themselves with excess net operating losses (NOLs) in 2010 and without sufficient income tax in a carryback year to use NOLs. Such taxpayers would be well advised to consider a 10-year carryback of an SLL, if available. If an SLL is incurred during 2010 where there was no overall NOL, a Section 165(i) election may free up the otherwise trapped and unused SLLs. A disaster loss deduction under Section 165(i) would generally not be an SLL.
Most states that follow the Internal Revenue Code allow the disaster loss deduction acceleration election under Section 165(i); however, a state-by-state comparison is recommended.
Nuts and Bolts of Claiming a Disaster Loss Deduction
A disaster loss deduction can’t exceed the uncompensated amount that would be determined on the basis of the facts existing at the date the loss is claimed. Such facts need to be carefully documented (e.g., tax basis in the property damaged or destroyed, fair market value immediately before and after the casualty, cost of repairs, and residual or salvage value of the property). As alluded to in our earlier article, other costs may also be incurred by reason of a natural disaster, although they might not be afforded casualty loss characterization under Section 165 (e.g., reversing vacation pay accruals, incrementally higher costs of operations related to the use of outside contractors, utilization of alternative plants, changes to logistic operations, etc.). However, these other costs may necessitate a revision to estimated tax payments and quarterly income tax accruals.
Appraisals can be used to establish the amount of a disaster loss deduction. In addition, Section 912(a) of the Taxpayer Relief Act of 1997 added a provision that allows taxpayers to use “alternate” types of acceptable appraisals to establish the amount of a disaster loss deduction. This provision permits taxpayers to use an appraisal made for purposes of getting a federal loan or guarantee to establish the amount of the disaster loss deduction.
If a taxpayer wants to make the election under Section 165(i), it must be made on or before the later of (1) the due date for filing its income tax return (determined without regard to any extension of time) for the taxable year in which the disaster actually occurred, or (2) the due date for filing its income tax return (determined with regard to any extension) for the taxable year immediately preceding the taxable year in which the disaster actually occurred. Thus, for a calendar-year taxpayer, the election must be made no later than the due date for filing its 2011 income tax return. The election can be made on an originally filed return, an amended return or a claim for refund showing that the election has been made. The additional extension of time provided to file your 2010 return, as indicated above, also provides some additional time to complete a thoughtful analysis of whether to include a disaster loss deduction in your originally filed 2010 tax return. The election should specify the date(s) of the disaster and the city, town, county and state in which the property was damaged or destroyed. If a Section 165(i) election is made, it applies to the entire loss. If your potential refund resulting from the election exceeds $2 million, the timing of receipt of your refund would not be delayed by the normal Joint Committee review procedures, as provided in Section 6405(c).
Affected taxpayers should write “Hurricane Irene” at the top of the form along with the designation “Section 165(i) Election” to expedite refunds. Once made, the election is irrevocable after 90 days, according to IRS regulations — although the Tax Court in Matheson (see 74 TC 836) ruled that this IRS regulation was invalid. The Tax Court’s view was that the intent of the legislation allowing for the election was to give taxpayers immediate help, but a comparison of the relative tax benefits might not be possible until the time for a taxpayer to file its return for the year of the loss.
Alvarez & Marsal Taxand Says:
An election under Section 165(i) to accelerate a disaster loss deduction to the preceding year can be the silver lining in the otherwise black cloud of a hurricane. However, whether to pursue this election or not requires careful analysis of your company’s overall tax position. Finally, don’t underestimate the importance of good documentation in supporting your disaster loss deduction with taxing authorities as well as proving your claim to the satisfaction of insurers.
Managing Director, New York
Stephanie DeYoung, Senior Director, contributed to this article.
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