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I paid wages to my employees even though I was unable to operate my business. Do I get a tax credit?
If your business had to shut down for a period of time due to the California wildfires, you may be eligible to take a tax credit on your 2017 tax return.
A tax credit of 40% of up to $ 6,000 of qualified wages (max credit is $ 2,400 per employee) is available to eligible employers in the California wildfire disaster zones, who were unable to operate their businesses (but continued to pay wages) from the date of the disaster. The employer is required to reduce the amount of their deduction for salaries and wages by the amount of the credit. An eligible employer is one who conducted an active trade or business in the California wildfire disaster zone on 10/8/17 and whose trade or business was inoperable on any day after 10/8/17 and before 1/1/18 because of wildfire damage.
The employee retention credit is calculated on Form 5884-A Credits for Affected Disaster Area Employers and flows to Form 3800 General Business Credits. If you are unable to take the credit in the current year due to tax liability limitations, you can carry it forward 20 years.
(Special Thanks to Vicki Mulak, EA, CFP for her compendium on disasters)
How do I report the Casualty on My Tax Return?
How do I report the Casualty on My Tax Return?
For tax purposes, we must first determine if we have a gain or a loss. From a high level, a gain or loss is calculated by taking the insurance proceeds less your cost basis in the property. Let’s say you purchased your home for $350k and your home was destroyed in a fire and you received $800k of insurance proceeds, then your gain on the casualty could be $800k – $350k = $450k gain. If you were uninsured, then your loss could be $0-$350k = $350k loss. (We say “could be” in this description above, because this is a very simplistic overview of the calculation. There is a LOT more that goes into it which is why we recommend you work with an Enrolled Agent or other qualified tax professional when calculating your gain or loss on your casualty).
Reporting a Loss
The tax deductible portion of the loss is calculated on Form 4684. While the form is straightforward, obtaining the amounts to put on the form is not so obvious, particularly when there is a complete loss. Many taxpayers, unless they have electronic copies of their records backed up on a cloud service, will struggle to obtain the cost of the house. If you purchased your house, then those records may be available from the Title Company or your County Recorder’s Office. If you built your house your challenge will be much more significant.
Calculating the loss is no easy task. The IRS has provided “safe harbor” methods that taxpayers can use in Revenue Procedure 2018-08. The advantage of using a safe harbor method is that you do not need to attached detailed documentation to support the loss calculation. The safe harbors are:
- If the cost of repair is less than $20,000, then you can use the lesser of two written estimates. Both estimates must break down the repairs and itemize the costs to restore the property. Costs may not be used that increase the value of the property.
- If the cost of repair is $5,000 or less, then a good-faith estimate may be used. The taxpayer must maintain records detailing how the estimate was prepared.
- You may use the estimated loss determined by the insurance company for the repairs.
For federally declared disasters:
- You may use a signed and binding contract with an independent contractor for the repairs (or reconstruction) of the house. The estimate must show itemized costs to restore the property. Costs for improvements or additions that increase the value must be excluded.
- You may use the appraisal prepared for the purpose of obtaining a loan from the Federal Government that sets forth the loss.
For personal belongings Revenue Procedure 2018-08 details in Section 5 how to evaluate your loss and the depreciation factors to be used.
Revenue Procedure 2018-09 elaborates on Revenue Procedure 2018-08 and includes indexes that can be used in calculating the loss. Anyone preparing an estimate of the losses from such disasters must be familiar with the content of the two Revenue Procedures. Note that the adjusted basis must be used to calculate any losses. For personal residences this is likely the cost to purchase the house plus significant improvements less tax credits received (e.g., energy improvements). For income-producing property the adjusted basis is also reduced for depreciation that was allowed or allowable whether taken or not.
Reporting a Gain
Disaster gains for your primary residence may be addressed in one of or a combination of two ways. The first is the personal exclusion for the sale of your primary residence identified as IRC §121. That could exclude up to $250,000 in gains for each person. The information of the sale should be reported on Form 8949 with an adjustment in basis up to the limit to reduce the gain. Documentation should be attached to the return to substantiate the calculation of the gain.
The second tool is the deferral of the gain using IRC §1033. This results in an adjustment of the basis of the new property for the gain deferred. Long term this adjustment will increase the capital gains should the property be sold. With this tool all details in connection with this deferral must be included with the tax return. This includes the description of the property, date and type of conversion, computation of gain (i.e., documentation on the adjusted basis of the property, calculation of the value of the damage, breakdown of the payment by the insurance company, etc.), decision to replace, etc. If the property is replaced with different like property, then there must be documentation attached to the return in the year that the replacement property is obtained. This may mean that documentation of the details is attached to two separate tax returns.
Relief for victims of the December 2017 Southern California Fires and mudslides
Victims of the wildfires, flooding, mudflows and debris flows that took place beginning on Dec. 4, 2017 in parts of California may qualify for tax relief from the Internal Revenue Service. The President has declared that a major disaster exists in the State of California. Following the recent disaster declaration issued by the Federal Emergency Management Agency, the IRS announced today that affected taxpayers in certain California counties will receive tax relief. Individuals who reside or have a business in Los Angeles, San Diego, Santa Barbara and Ventura Counties may qualify for tax relief.
The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. Relief includes:
- Certain deadlines falling on or after Dec. 4, 2017 and before April 30, 2018, are granted additional time to file through April 30, 2018. This includes 2017 individual income tax returns normally due on April 17, 2018. It also includes the fourth quarter estimated tax payment normally due on Jan. 16, 2018
- Penalties on payroll and excise tax deposits due on or after Dec. 4, 2017, and before Dec. 19, 2017, will be abated as long as the deposits were made before Dec. 19, 2017.
The Franchise Tax Board and the California Department of Tax and Fee Administration will follow these postponement periods for individuals and businesses in these areas.
If an affected taxpayer receives a late filing or late payment penalty notice from the IRS that has an original or extended filing, payment or deposit due date that falls within the postponement period, the taxpayer should call the telephone number on the notice to have the IRS abate the penalty.
The IRS automatically identifies taxpayers located in the covered disaster area and applies automatic filing and payment relief. But affected taxpayers who reside or have a business located outside the covered disaster area must call the IRS disaster hotline at 866-562-5227 to request this tax relief.
I received a check for my personal property. Is it taxable?
If your personal residence or its contents were destroyed in a federally declared disaster (like the North Bay Fires in October ’17 and Southern California fires in December ’17) and you receive insurance proceeds for your unscheduled personal property that results in a gain, that gain is not taxable to you. (Unscheduled property is your belongings that are not specifically itemized on your insurance policy.)
E.g. You are a renter and your home was destroyed in the fire. The cost basis of your belongings was $10,000 You receive a check from your insurance company for $20,000 that covers your unscheduled personal property. You do not need to report this gain on your tax return.
If your insurance doesn’t cover everything you lost, then you may be able to take a casualty loss on your tax return.
E.g. You are a renter and your home was destroyed in the fire. The cost basis of your belongings was $10,000 You receive a check from your insurance company for only $5,000 that covers your unscheduled personal property. This results in a loss and thus you will want to work with a professional tax preparer to see if you can take a casualty loss on your tax return.
Do I really need an appraisal?
Question: My tax advisor suggested that I obtain an appraisal of my property that reports the value before the fire and the value of the land after the fire in order to document the reportable loss. My insurer has advised that they are going to provide me with an appraisal, but my tax adviser still suggests that I pay a certified appraiser and obtain my own documentation. Is this necessary?
Answer: For tax purposes you need a market appraisal. This is the amount a willing buyer would have paid for your property before the fire, and the amount that a willing buyer would pay for the land after the fire. An insurance appraisal is not necessarily going to provide that information. The insurance company appraiser is trying to establish the cost to replace the destroyed home to its previous condition. Even if the insurance appraisal provides market value, your own appraisal may help you with necessary documentation if you want to appeal the insurer’s report.
Insurance has sent me a check for the loss of my house. Is it taxable?
The answer to this and most tax questions is: It depends. There is a potential for the insurance payments to be taxable and it depends on the facts and circumstances of each case.
Casualty Loss: If a Home Owner was uninsured (or under-insured) and lost their house, they could have a sizable casualty loss. A casualty loss is taken on your tax return.
Casualty Gain: If they were insured and if the insurance award is greater that the home owner’s basis (original purchase price plus improvements) then there is a possible taxable gain. The insurance payment for the loss of the house is considered the Sales Price. Comparing the Sales price to the Basis determines if there is a Taxable Gain.
WAIT, YOU ARE NOT LISTENING. THERE WAS NO SALE.. MY HOUSE WAS DESTROYED IN THE FIRE.
Yes, you are right. It seems unintuitive but this is the way the tax code works. When you get insurance money it is treated like a sale of your property.
Example: If you bought your house for $200,000 and you receive $500,000 in insurance benefits, there is a $300,000 gain.
SO, DO I HAVE TO PAY TAXES ON THAT GAIN?
Luckily, there are two IRS code sections that can reduce or eliminate the gain from the insurance received. Section 121 covers the exclusion of Gain from a Principle Residence and Section 1033 covers Involuntary Conversions which are losses that happen as a result of events such as Fire, Earthquake, Flood, etc.
Using Section 121
Since the destruction of your personal residence is treated as a sale of property, for purposes of the section 121 exclusion if the taxpayer otherwise qualifies (that is, during the five-year period ending on the date of the fire, the home has been owned and used by the taxpayer as their principal residence for two years or more) part of the gain ($250,000 for single taxpayers and $500,000 for married filing jointly taxpayers) may be excluded.
Example: Using the example above, if you have a $300,000 gain but you were single and qualified for the Sec 121 exclusion, then you could exclude $250,000 of the $300,000 gain. Leaving you with a gain of only $50,000.
Using Section 1033
This section allows you to defer recognition of the gain on your tax return assuming the tax payer reinvests the proceeds in a replacement property within defined time limits. Note: This is just a deferral of the gain. The basis of the replacement property is adjusted for the deferred gain and thus when you sell the property, you could recognize the gain at that time. The rules around this are quite complex, thus we have not gone into all the details in this article.
The calculations around the casualty gain or loss are complicated and using the Sec 121 and Sec 1033 exclusions are even more complicated and there are special rules if your loss is due to a federal disaster (such as the North Bay fires) thus we recommend that you consult with your Enrolled Agent or other tax professional when preparing your tax return to ensure you get all the tax benefits you deserve.
I received a check for living expenses. Is it taxable?
If your home was destroyed in the fire and you must temporarily live somewhere else while your home is repaired or rebuilt, insurance payments for increased living expenses are excluded from income (i.e. not taxable).
This exclusion from income only applies to the excess of actual living expenses over the normal living expenses the taxpayer would have incurred during that period. (For these purposes, actual living expenses are defined as the reasonable and necessary expenses incurred because of the loss of use or occupancy of the principal residence to maintain the taxpayer and members of their household’s customary standard of living. Generally, expenses such as rent and utilities at the temporary residence, restaurant meals which normally would have been prepared at home and transportation expenses fall under this category). Insurance payments received for additional costs incurred in renting suitable housing and any extraordinary expenses for transportation, food, utilities and miscellaneous items are also excluded from income.
Payments received for the loss of rental income or reimbursements for damage or loss of real or personal property do not qualify for the income exclusion. If the taxpayer’s principal residence was used partially for business/rental, the portion of reimbursements attributable to the nonresidential use of temporary replacement property will be included in income.
Here is a rough summary of payments that are taxable vs. not taxable
Taxable Payments
- Normal Living Expenses
- Disaster unemployment assistance
- Expenses attributable to business use
- Loss of rental income
Not Taxable Payments
- Extra expenses for renting, transportation, food, utilities, misc services incurred while unable to use home because of casualty.
- Temporary increase in living expenses
Example 1 – Pat and Chris lost their home in the Tubbs fire. Before the fire, their monthly normal living expenses were $2,500 Mortgage/property taxes, $500 Utilities, $400 food = $3400 Normal Living expenses.
After the fire, their living expenses are $2500 Mortgage/property taxes (old house), $50 Utilities (old house), $2000 Rent (new temporary home), $250 Utilities (new home), $600 Food = $5400 Current Living expenses.
$5400 – $3400 = $2000 net increase in living expenses.
If insurance paid them $2000 then the reimbursement would be non taxable because it is equal to the net increase in living expenses (basically the rent for the new place).
If insurance paid them $2500, then $2000 would be non taxable and $500 would be taxable. They would still get their usual mortgage interest/property tax deductions which could help offset the additional taxable income.
See Treasury Regulation §1.123-1 for more information
Can I use my retirement funds to help pay my bills following the fire?
If you have a retirement plan through your employer you may be able to get access to that money to pay some of your bills associated with the California wildfires.
If you have a retirement plan through your employer (e.g. 401(k) or 403(b)), usually you cannot withdraw any of that money until your employment with them ends. An exception to this is if your retirement plan allows for hardship distributions. Hardship distributions are made to the employee if there is an immediate and heavy financial need. Normally, the rules around these distributions are quite strict and very few people qualify for them. However, following the California wildfires, the IRS has issued a notice that those living in the federally declared disaster area associated with the wildfires of October 2017* qualify for hardship distributions from their plans.
The distribution must be taken between October 8 2017 and March 15, 2018 to qualify under this relief. At this point in time there is no relief yet from the normal tax consequences of using such money (e.g., the 10% federal tax penalty for early withdrawal from an IRA).
Despite the relaxed rules, you will need to work with the plan administrator or financial institution to enable this to be done. It is also possible that you, as a victim, are more invested in the solution than the management company. So it may require extra effort. If that is the case, you are encouraged to work with an Enrolled Agent (particularly one who is a tax law code and IRS announcement junkie) to assist in communicating the provisions.
*The counties that qualify for this relief are: Butte, Lake, Mendocino, Napa, Nevada, Orange, Solano, Sonoma and Yuba.
My Payroll Tax reports are due but I won’t be able to file on time. Will I have to pay a penalty?
The 3rd quarter payroll reports are due on Tuesday October 31st — this includes Federal Form 941 and California Forms DE9 and DE9C. If you were not able to file the reports on time due to the North Bay Fires, you have additional time to file these reports
- IRS Form 941 – These reports are now due on January 31, 2018. This is an automatic extension if you live in one of the counties deemed a federal disaster.
- California Form DE9 & DE9C – relief from the state is NOT automatic. To request relief from the EDD, you must file your reports within 60 days from the original due date and include a letter requesting an extension. The letter should specifically request an extension of time under Section 1111.5 of the CUIC and must also provide detailed information as to why the report could not be submitted in a timely manner. Mail the letter and the return to State of California / Employment Development Department / P O Box 989071 / West Sacramento CA 95798-9071
Counties Include:
- The North Bay counties included in the Federal and State Wildfire disaster area are: Butte, Lake, Mendocino, Napa, Nevada, Orange, Solano, Sonoma and Yuba
References:
My sales tax return is due and my records were burned in the fire! Can I get relief?
If you are a business owner or fee payer who is directly affected by a disaster declared as a CA state of emergency, you may be eligible for relief of tax return due dates, interest and penalties administered by the California Department of Tax and Fee Administration (CDTFA which was formerly known as the SBOE).
Step 1 of the relief process is to request an extension of time to file your return:
- If you do not have an Express Log-In, then please call the CDTFA at 1-800-400-7115 with your account number and they can help you with your extension.
- If you DO have an Express Log-In, you can request the extension online. When you login, request an extension of time to file your sales tax return. If your extension request is due to a recognized disaster then you have 3 additional months to file your sales tax return.
Step 2 is to locate your records and to file your return and pay your tax due within the 3 month extension period.
If your disaster relief extension is granted, then penalties and interest are automatically waived as long as you file and pay within the 3 month extension period.
If relief is not granted but you think it should be, then you can contact the CDTFA by telephone or login with your Express Login, just like you did above, and request relief from penalties and interest.