October 1999

CPAs Can Help Disaster Victims

Tropical Storm Floyd Serves as Reminder tp6

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Tropical Storm Floyd provided New Yorkers with vivid pictures of the devastation natural disasters leave behind. The storm also serves as a reminder that CPAs knowledgeable in disaster recovery can help their clients--both individuals and businesses--get back on their feet after suffering extreme damage or loss.

When the federal government declares a state or county a disaster area, CPAs can counsel clients suffering from property damage on how to maximize financial relief through casualty or disaster loss deductions and business interruption policy insurance claims.

Casualty Losses

For personal casualty losses, taxpayers must file form 1040 and itemize deductions on Schedule A to claim a casualty of nonbusiness property. When the President declares an area a federal disaster area, the Internal Revenue Service allows taxpayers to deduct casualty losses on the original or an amended Hurricane filed return for the taxable year immediately preceding the taxable year in which the disaster occurred. Victims may also reduce their remaining current-year estimated tax payments or withholding in anticipation of a current-year casualty loss deduction.

To deduct a casualty loss, the victim must first calculate the loss and then determine any limits on the deductible amount. To compute a casualty loss, subtract any insurance and other reimbursement received or expected from the smaller of the property's decrease in fair market value as a result of the casualty or the adjusted basis of the property before the event.

If the taxpayer's insurance covers the damaged property, the IRS requires the individual to file a timely reimbursement claim in order to qualify for the casualty loss deduction for tax purposes. The taxpayer must subtract the receipt of insurance or other types of reimbursement for the tentative loss (the lower of decrease in fair market value or adjusted basis).

In addition to insurance, victims can receive other reimbursements, including:

The forgiven part of a federal disaster loan under the Disaster Relief and Emergency Assistance Act;

The repayment and the cost of repairs by the person who leases the taxpayer's property;

Court awards for damages for a casualty (the amount collected) minus lawyers' fees and other necessary expenses; and

The repairs, restoration, or cleanup services provided by relief agencies.

The IRS considers insurance, grants, gifts, and other payments received to help after the disaster as reimbursements only if they are specifically designated to repair or replace the property. If the money is designated for other purposes, or if there are no conditions on its use, it is not a reimbursement even if used to restore the property.

Taxpayers must often file returns before they know the exact amount of insurance or other reimbursement. Where there is a reasonable prospect that they will receive additional reimbursement for part or all of a casualty loss some time in the future, taxpayers must take into account the expected reimbursement when computing the loss or gain from involuntary conversion. Individuals should make their best estimate of the reimbursement and file the return claiming the loss in the year of the casualty. (They may report the gain in the year they receive the reimbursement.)

If individuals eventually receive less reimbursement than they estimated, they can claim the difference as a loss in the year they receive such lesser amount. They should not amend the original return to reflect this difference. If the original transaction resulted in a gain that was deferred, the difference in reimbursement will require an upward adjustment to the basis of the replacement property.

After individuals compute the loss, they must determine the deductible amount. If the loss was to property held for personal use, the IRS imposes two limits on the amount deductible: Taxpayers must reduce each casualty loss by $100, and then further reduce the loss by
10 percent of their adjusted gross income. If there is more than one casualty or theft loss, this 10 percent limit applies to the total of all losses for the year. The 10 percent rule, however, does not apply if casualty gains for the year are more than casualty losses.

Disaster Losses

A disaster loss--a loss attributable to a casualty occurring in an area that the President declares a disaster area--also entitles taxpayers to federal assistance. The IRS extends disaster loss treatment to personal residences that have been rendered unsafe in a disaster area and ordered demolished or relocated by state or local government.

The deduction calculation for a disaster loss follows the same rules as any other personal casualty loss. However, if the taxpayer elects to claim the loss on the return immediately preceding the year of the disaster, the IRS views this loss as sustained in the preceding taxable year.

Disaster Tips for Businesses

While some business owners may be aware of the preliminary precautions to take in a disaster, many do not know how to compute losses when filing an insurance claim under their business interruption policy; this is another area where CPAs can provide counsel. Businesses that closed due to Floyd's flood damage, for example, may not realize they can collect from their insurance companies amounts representing profits they would have made had they remained open.

"The time of closure also plays a role because the loss of profits may be greater depending on various seasonal factors," NYSSCPA General Committee on Public Relations member Alan Strauss said. "It is crucial that we let our clients know we can help them receive the fair settlement from their insurance companies due to them under their business interruption policy."

CPAs should also talk to their clients about the modifications to tax code 1033H--Special Rules for Property Damage by Presidentially Declared Disasters. Many business owners do not know that changes in this provision that took effect in 1995 afford them the opportunity to create something new out of a disastrous situation.

"If your client owns a destroyed business or income-producing property located in a federal disaster area, it is not required that the aid received be put toward reopening the same business--or even starting a similar business," NYSSCPA Tax Division and Executive Committee member Steven P. Valenti said. "However, the cash must be used to open some type of business."

Tara Oolie assisted with this article.

Conference to Address Disaster Plans

Sid Edelstein and Peter Frank, chair of the Society's General Committee on Consulting Services, will present Dealing with Disaster: Contingency Plans and Disaster Planning on November 23, the second day of FAE's Emerging Technologies Conference at the New York Hilton Hotel and Towers in New York City.