What Tax Breaks Do Disaster Victims Get?

Let’s time travel back to a couple of days before Santa descended chimneys in 2017, which was when Congress okayed and President Donald J. Trump signed the Tax Cuts and Jobs Act (TCJA). Both supporters and critics of the 45th president agree that the TCJA was his signature legislative accomplishment, though critics would add that it was his sole accomplishment.

As is usually true of overhauls of the Internal Revenue Code, the TCJA helps some and hurts others. Among other things, it curtails deductions for casualty and theft losses. 

Our lawmakers decided not to make the new rules for such losses permanent. They apply only for 2018 through 2025; the official line is that, come 2026, the old ones for 2017 and earlier years are supposed to go back on the books. 

Let’s wait and see. Between 2021 and 2026, there’ll be a presidential election and two mid-term elections. 

The old rules already imposed severe limits on deductions for losses claimed by property owners whose homes, household goods and other property suffer damage or destruction due to unpredictable events. (Internal Revenue Code Section 165 (h)). 

Events pass muster only if they’re “sudden, unexpected or unusual.” The wide-ranging list of unpredictable misfortunes includes earthquakes, fires, floods, hurricanes, landslides, lightning, sonic booms, storms, tornadoes, tsunamis, and volcanic eruptions. 

The big barrier under the old rules: Section 165 (h) specified that losses for personal-use assets, after reductions for insurance reimbursements, generally were deductible only to the extent that the total amount in any one year surpassed 10 percent of an owner’s adjusted gross income. More in a moment on insurance.

The TCJA retained the 10-percent threshold, and added restrictions for 2018 and later years. Generally, owners are able to avail themselves of deductions for uninsured casualty losses only when they satisfy two requirements. 

First, they suffer losses that are attributable to natural disasters like floods and wildfires. Second, losses occur in disaster areas declared by the president to be eligible for federal assistance. 

Center stage for climate change. Paul Krugman, recipient of the Nobel Prize for economics in 2008 and New York Times Opinion columnist, recently weighed in on the present and future consequences of climate change. 

His column for October 21, 2021, put it this way: “We’ve already seen the costs imposed by the leading edge of climate change–severe droughts, a proliferation of extreme weather events. The overwhelming scientific consensus is that such costs will get far worse.”

Will Mr. Krugman’s jeremiad motivate President Biden and his successors? Sure.

It’s easy for them to show that they’re responsive. They just have to dispense lots more disaster designations that allow property owners to claim their losses. Those presidential designations will be in response to lots more events attributable to global warming. 

Will the columnist’s comments motivate me? Sure. 

I just have to use several columns to remind accountants and other tax professionals on how to quickly counsel clients who unexpectedly become disaster victims. They’ll expect instant advice on how to take maximum advantage of deductions available for them, as well as guidance on how to sidestep pitfalls.

My client roster includes Hester, a disaster survivor. She beams when I explain that the IRS stands at the ready to partially ease the hurt for her and others who suffer serious property damage. The agency allows Hester to write-off uninsured losses on her returns. 

No surprise, though, that Hester harrumphs when I explain that the Gang of 535 (538 if the District of Columbia becomes the fiftieth state and. like Wyoming, elects two senators and one representative) decided that the IRS shouldn’t dole out relief when she suffers losses that are penny ante. Hester’s permissible write-off will be shockingly smaller than she and many disaster survivors anticipate.

Let’s begin with some low-hanging fruit. Long-standing regulations generally prohibit any write-offs for casualty or theft losses by Hester and other filers who opt not to itemize on Form 1040’s Schedule A for things like state and local property and income taxes and claim the standard deduction amounts that are available to nonitemizers, which, by the way, were sharply increased by the TCJA.

Only itemizers are eligible for tax relief. Even then, casualty or theft deductions are subject to several limitations.

Two floors for personal-use property losses. First, Hester has to subtract $100 for each loss, after taking into account insurance reimbursements. Second, as noted above, losses have to exceed 10 percent of her adjusted gross income. 

What’s ahead. Part two will take a closer look at those two floors and focus on more highlights of write-offs available for individuals who suffer losses attributable to unexpected events like wildfires and floods in disaster areas that are eligible for federal help.