Most Americans enjoy a secure and carefree lifestyle… clean water, restaurants abound and first responders are there for those times when things go askew. Life is mighty darn good… until it isn’t.
Inevitably, somewhere, sometime, disaster will strike. When disaster strikes, we all need help; and help goes beyond preparation of stocking your pantry and stockpiling clean water. When disaster strikes, our lives may get turned upsidedown, yet still move forward. The next thing you know, it’s January and once again it’s time to file a tax return.
This WEBlog is intended to give the average taxpayer a cursory overview of disasters and the filing of tax returns after disaster strikes.
So, something – some disaster has occurred. It may be rain or flood; fire or snow; hurricanes, tornadoes, landslides, earthquake… all natural disasters which occur quite regularly in the United States. There are also manmade disasters such as a building collapse, an explosion, train derailments or toxic chemical spills – things which, quite frankly happen far more often than they should. All of these events have the potential to create the “casualty loss” – a term used in taxation to describe an identifiable event that is sudden, unexpected or unusual 1 in which a taxpayer suffers an unrecoverable loss of an asset due to theft, damage or destruction.
How does a disaster – or casualty loss – affect the average taxpayer? Simply put, a taxpayer may be able to claim a deduction against taxable income for their loss, thereby reducing taxable income; and less taxable income means less tax owed. So… you’ve incurred the loss of an asset, you cannot recover the cost of the asset – through insurance or other legal means – and you need to replace that asset. A reduction in the amount of tax you owe may help you generate the cashflow needed for the replacement.
The rules for deducting casualty losses have changed over the years. As quoted from IRS Pub 547 “For tax years 2018 through 2025, if you are an individual, casualty losses of personal-use property are deductible only if the loss is attributable to a federally declared disaster (federal casualty loss)”. There are three types of losses: federal casualty losses, disaster losses, and qualified disaster losses. I will not be discussing the details of each type of loss other than to say if you suspect you’ve suffered a casualty loss and want to explore taking a deduction on your tax return, you need to read through IRS Pub 547 to determine if your loss is deductible.
How does the average taxpayer determine if a disaster where they live/or/work will affect them with respect to filing their tax return? We know from IRS Pub 547 that the only casualty loss which is deductible through 2025 to an individual is that which is attributable to a “federally declared disaster …” This IRS webpage is a great place to look to determine if your loss occurred due to a federally declared disaster. 2 Click on the year; a description of each disaster and the IRS announcement for taxation relief will be listed. Find the announcement that pertains to you and click on the link for the details (see link below.)
Example #1 — California saw a surge of rain and snowfall, followed by flooding and landslides, during the early months of 2023. People were stranded, some for many weeks, and for many reasons – their doors, windows and garages were literally under snow; their vehicles were under snow; the roads were inaccessible as they were also under snow. In areas of extreme rainfall, streets were flooded; homes were flooded; businesses were flooded; and with flooding often come landslides, further burying homes, businesses and streets. Businesses remained closed while business owners were stranded in their homes; yet rent, utilities, insurance, and other business expenses continued to accrue while business revenue dropped as low as $0.00.
Upon clicking on this announcement on the Tax Relief in Disaster Situations page on irs.gov, you’ll be taken to a page describing the disasters: providing information on a probable extension of time to file the tax return and possibly and extension of time to pay tax due; a description of the covered disaster area (look for your city, county, state); a description of who is considered to be an “affected taxpayer” along with a discussion on Casualty Losses and Other Relief.
Use Caution when searching – the example above is the second IRS announcement for California in 2023. The first announcement extended filing and payment deadlines through May 15, 2023; continued rain and snowfall compelled the IRS to extend those deadlines further to October 16, 2023; then by October 16, 2023, the IRS again extended the deadline to November 16, 2023. You should use care in selecting the correct announcement for your suspected federally declared disaster, and you may wish to check for additional extension prior to filing.
“I believe I’m in a federally declared disaster area and have suffered a casualty loss; what should I do now?” If you believe you/or/your business is located in a federally declared disaster area and you/or/your business have incurred a deductible casualty loss, you should contact your tax professional immediately. Don’t wait until next year when your tax filing is due. Your tax professional may be able to help you get started on reconstructing business and/or personal tax records; or obtain prior years’ tax records in the event you’re using a tax professional new to you. If nothing else, it gives your tax professional a “heads up” that your tax preparation will be more involved in the upcoming year.
“When am I able to take the casualty loss on my tax return?” A casualty loss is generally declared and deducted in the year in which the loss occurred 3; however, this statement is misleading. In order for a casualty loss to be permitted, the taxpayer must first be ‘unable to recover’ the value of the loss. This generally means filing an insurance claim and waiting for it to: 1) be denied, or 2) be paid, but at an amount lower that the fair market value of the lost asset. Sometimes the insurance company will resolve the claim quickly, other times, not so quickly. If the insurance payout covers the full amount of the loss, there’s no casualty loss to declare.
Example #2 — You incurred a loss in Year A and expect the insurance to cover your loss; you won’t declare a casualty loss because the monies are expected to be recovered. In Year B there is a dispute with the insurance company on the payout/or/non-payout; you may be eligible to declare a casualty loss that year – depending upon facts and circumstances. This would be an example of an instance when working with a tax professional working on the casualty loss could be beneficial to you. If you’re unable to take the loss in Year B, you may be able to take the loss in a future year – the year in which the matter with the insurance company has been finalized and there will be no further reconsiderations nor disputes. Again, if the final insurance payout covers the full amount of the loss, there’s no casualty loss to declare.
“When is my tax return due?” The IRS will provide guidance for taxpayers located in a federally declared disaster area. Most often, they will extend the date by which you must file your return – which will give you time to reconstruct your books and records, if that should need to be done. Many states will follow whatever the IRS determines with respect to filing due date – however, you must check your state Department of Revenue website to confirm the state tax return due date and payment date.
Example #3 — During 2023, California was declared a federal disaster area in all counties except Lassen, Modoc and Shaster (no, I can’t answer why they were excepted.) The IRS granted an automatic extension for filing and making certain tax payments until October 16, 2023; Franchise Tax Board for California conformed to the same extension to file and pay taxes.
Tax authorities don’t always extend the date by which your tax is due, so be careful when reading the IRS and DOR guidance; look specifically for mention of tax owed and the date by which it must be paid.
“I won’t be ready to file my return by the original April due date; should I file a request for extension?” The simple answer is, “No, not if the IRS specifically granted an ‘automatic extension of time to file.” A more complex answer is, “It depends.” Is there a reason you believe you need to file an extension?
Example #4 — I filed a client with several business properties located within a federally declared disaster area; therefore, the client was entitled to relief under the disaster provisions with an automatic extension of time to file and pay tax due.. However, the tax mailing address – the address shown on the return – was clearly located outside of the disaster area. For situations where entitlement to disaster relief is not “clearly evident” on the tax return as a stand-alone document, then you should file a request for extension out of sheer prudence.
Example #5 — It has been suggested by tax professionals that individuals and/or businesses considering the refinance of a loan should file a request for extension in the event the loan officer asks for it.
“I’ve lost my tax records in the disaster; how can I file the return now?” There may be a need to reconstruct your tax records, if those records were lost due to the nature of the disaster. The IRS has created a Newsroom article, “Reconstructing Records After a Natural Disaster or Casualty Loss; IRS Provides Tips to Help Taxpayers” 4 to help taxpayers get started gathering new tax information. This is a fabulous place to start!
Some items of reconstruction may be easy. Let’s say your tax folder was destroyed in a fire – your W2’s, Interest and Dividend statements, Mortgage Interest paid, K1’s from pass-through entities. You could go back to the issuer and request another copy; or you could request a ‘Transcript, All Items of Income’ direct from the IRS after August 1st and you’ll receive all those payor documents with one request. The discussion in the IRS Newsroom article includes some items which the average taxpayer will not be familiar with (such as the ‘Transcript, All Items of Income”); in the event you have questions or need help reconstructing records, I strongly urge you to contact your tax professional immediately to discuss your specific situation.
Some items of reconstruction may be not-so-easy. Let’s say you have a large piece of equipment you use in your business, and it was a total loss after the disaster. If your purchase records of the equipment were also lost, you don’t have proof of purchase nor purchase price. If you’ve been depreciating the equipment on your tax returns, you may not have your depreciation schedules for the past – which will be needed. You’re going to need to reconstruct this information and calculate a salvage value for the asset post-disaster. Add to this the fact you may have multiple pieces of equipment, a building, vehicles… these are all things which may need to be reconstructed; AND, the casualty loss deduction is for ‘unrecoverable losses’ – which means before you are permitted a deduction for the loss you must first file a claim with any insurance company which may reimburse you for the loss(s) or a portion, thereof. Bottom line, reconstruction of information required to claim the casualty loss deduction may entail a great amount of footwork.
“I’m able to file my tax return, but I’m not able to pay the taxes, what should I do?” There’s no reason to delay filing your tax return because you don’t have the cashflow to pay the amount due; not filing the return isn’t going to change your ability to pay. File your return and discuss with your tax professional what your options are for paying your tax. Your tax professional will assess your situation and let you know what options are available to you – whether it be a simple ‘late payment of the tax’, establishing a payment plan, or in extreme cases possibly filing an Offer in Compromise to reduce the amount of tax which is owed. Certain taxpayers may need to consider bankruptcy – but that’s a discussion to be held with an attorney, and not part of this WEBlog.
One last note – it’s possible the disaster has forced you to move, either personally or to relocate your business. Either way, there may be a need to change your address with the tax authorities before you file your return – while you’re reconstructing your tax information.5 You may want to check out another of my WEBlogs – “When You Move” – for information on changing your address.
Hopefully you now have some insight into how to get information in the event disaster ever befalls you or your business. You begin by confirming whether or not you may be entitled to a casualty loss deduction on your tax return; you follow up by gathering your tax information and loss information, including a foundation for your valuation of the property lost; and you finish by filing the tax return. While you could file a self-prepared return complete with a casualty loss deduction, I strongly recommend you work with a qualified tax professional. The rules for casualty losses change often, very often. Without complete information, you could delay the processing of your return and the allowance of your loss.
WEBlog research links
Federal list of disasters – : https://www.irs.gov/newsroom/tax-relief-in-disaster-situations
For Californians – California List of disasters 2023 (and back to 2015), Franchise Tax Board – https://www.ftb.ca.gov/file/business/deductions/disaster-codes.html
IRS links for disaster loss assistance – https://www.irs.gov/businesses/small-businesses-self-employed/disaster-assistance-and-emergency-relief-for-individuals-and-businesses