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The massive 5,593-page Consolidated Appropriations Act (CAA), which combined $900 billion in pandemic relief with a $1.4 trillion omnibus spending bill, was signed into law at the end of last year.
The legislation included a batch of new federal income tax disaster-relief provisions — some of which may come into play after the recent deep freeze in Texas and the South.
Here’s what you need to know:
Liberalized rules for deducting personal qualified disaster casualty losses
For 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) suspends federal income tax itemized deductions for personal casualty losses, except for losses due to federally declared disasters.
If, after considering any insurance proceeds, you have a personal casualty loss due to a federally declared disaster, you must first reduce it by $100. Then you must further reduce it by 10% of adjusted gross income (AGI). You can then write off the remaining loss, if any, as an itemized deduction — assuming you itemize.
Under a special rule, you can choose to treat a personal casualty loss due to a federally declared disaster as if it occurred before it actually occurred, if that gives you a better tax result.
The CAA grants tax relief to an individual taxpayer who has a net disaster loss for the tax year in question. For purposes of this relief, a net disaster loss equals the excess of your qualified disaster-related personal casualty losses for the year over your personal casualty gains, if any. (You can have a personal casualty gain if insurance proceeds exceed the tax basis of damaged or destroyed property.)
See also: IRS pushes back tax-filing deadline for Texas and Oklahoma taxpayers after devastating winter storm
A qualified disaster-related personal casualty loss is one that arises in a qualified disaster area on or after the first day of the incident period of the qualified disaster and that is attributable to the qualified disaster. The CAA increases the first subtraction for a qualified disaster-related personal casualty loss from $100 to $500. However, the 10%-of-AGI subtraction does not apply. In addition, the CAA treats the allowable net disaster loss as an addition to your standard deduction. So you can write off the loss even if you don’t itemize.
Key point: This CAA relief provision has a very limited shelf life. It only applies to net disaster losses in a qualified disaster area for which a major disaster is declared by the president between Jan. 1, 2020 and Feb. 26, 2021 (60 days after the Dec. 27, 2020 enactment of the CAA), as long as the incident period for the disaster began after Dec. 27, 2019 and before Dec. 28, 2020. Finally, any area for which a major disaster was declared only by reason of COVID-19 doesn’t count as a qualified disaster area for purposes of this CAA relief provision.
Tax-favored treatment for qualified disaster distributions from IRAs and retirement plans
If you receive a taxable distribution from an IRA or eligible tax-favored retirement plan before age 59½, you’ll be hit with a 10% early withdrawal penalty tax unless an exception applies.
The CAA exempts qualified disaster distributions from the 10% penalty tax. A qualified disaster distribution (QDD) is any distribution from an IRA or eligible retirement plan that: (1) is made on or after the first day of the incident period of a qualified disaster and before June 26, 2021 (180 days after the Dec. 27, 2020 enactment of the CAA) and (2) is made to an individual who sustains an economic loss due to the disaster and whose principal place of abode at any time during the incident period is within the qualified disaster area.
For any year, the total amount of distributions that you can treat as QDDs is limited to $100,000 reduced by any amounts treated as QDDs in prior years. The taxable amount of any QDD can be spread over a three-year period starting with the year of receipt, unless you choose to include the entire amount in income in the year of receipt.
Alternatively, you can recontribute a QDD to an IRA or eligible retirement plan within the three-year window that begins on the date you receive the QDD. You can then treat QDD and the related recontribution as a federal-income-tax-free rollover transaction. You can make your recontributions in a lump sum or you can make multiple recontributions.
When all is said and done, recontributed QDD amounts turn out to be federal-income-tax-free. But if you don’t recontribute a QDD quickly enough, you may have to pay an interim tax hit and then file an amended return to get the interim tax hit refunded. It’s complicated! Ask your tax advisor for details about how the recontribution deal works.
Key point: There are no restrictions on how you can use QDD funds. If you’re cash-strapped, you can use the money to pay bills and recontribute later (within the three-year window) when your financial situation improves. You can help out your adult kids now and recontribute later. Whatever.
Qualified disaster distributions used for eligible home purchases can be recontributed to achieve tax-free treatment
The CAA also allows an individual who receives a qualified distribution from an IRA or eligible retirement plan to recontribute, during the applicable period, the distribution to an IRA or eligible retirement plan and thereby achieve tax-free rollover treatment. For purposes of this rule, a qualified distribution is a distribution that: (1) is used to purchase or construct a principal residence in a qualified disaster area, and (2) is received during the period beginning 180 days before the first day of the incident period of the qualified disaster and ending 30 days after the last day of the incident period.
The applicable period for making a recontribution starts on the first day of the incident period of the qualified disaster and ends on June 26, 2021, 180 days after the enactment of the CAA.
Impact: This provision effectively allows you, as an eligible individual, to temporarily use money withdrawn from an IRA or eligible retirement plan to buy or build a principal residence and then recontribute the withdrawn amount as a tax-free rollover after you’ve found other funding sources.
Increased limit for retirement plan loans made after disasters
In general, the cumulative amount of loans from a tax-favored retirement plan to a plan participant (borrower) cannot exceed the lesser of $50,000 or 50% of the borrower’s vested account balance. The CAA stipulates that for a plan loan made to a qualified individual between Dec. 27, 2020 and June 26, 2021 (the 180-day period beginning on the date the new law was enacted), the loan limit is increased to the lesser of $100,000 or 100% of the borrower’s vested account balance.
A qualified individual is anyone who sustains an economic loss due to the disaster and whose principal place of abode at any time during the incident period of a qualified disaster is within the qualified disaster area. Qualified individuals are also eligible for relaxed plan loan repayment terms.
Employee retention tax credit for employers affected by qualified disasters
The CAA allows a new federal employee retention tax credit for wages paid by an eligible employer in an area declared as a federal qualified disaster zone between Jan. 1, 2020 and Feb. 26, 2021 (60 days after the CAA’s enactment date). For purposes of this credit, qualified disaster zones do not include areas covered by COVID-19-related disaster declarations.
The qualified disaster employee retention credit equals 40% of the first $6,000 of an employee’s qualified wages, for a maximum per-employee credit of $2,400. Qualified wages for this credit do not include any wages taken into account for purposes of claiming the COVID-19 employee retention credit.
An eligible employer is one who: (1) conducted an active business in a qualified disaster zone at any time during the incident period (as defined) of the qualified disaster and (2) saw their business became inoperable at any time during the period beginning on the first day of the incident period and ending on Dec. 27, 2020 as a result of damage sustained due to the qualified disaster. Consult your tax advisor for full details on this credit.
Bigger corporate charitable deductions for qualified disaster-relief contributions
As a general rule, a C corporation’s charitable contribution deduction cannot exceed 10% of the company’s taxable income, calculated before the deduction and with certain modifications. Excess contributions that cannot be currently deducted can be carried forward for up to five years and potentially deducted in those years, subject to the 10%-of-taxable-income limit.
The CAA defines a new category of corporate charitable contributions: qualified disaster-relief contributions. Deductions for these contributions can offset up to 100% of the contributing corporation’s taxable income. A qualified disaster-relief contribution is any qualified contribution that: (1) is paid between Jan. 1, 2020 and Feb. 26, 2021 (60 days after the CAA’s enactment date) and (2) is made for relief efforts in a qualified disaster area.
The bottom line
There you have it: the gist of tax disaster-relief provisions granted by the CAA. Hopefully you’ll never need to use them. Fingers crossed.
