- Legislation for Major Disasters
- Qualified Disaster Distributions
- Re-Contributing Withdrawals for Home Purchases
- Retirement Plan Loans
- Loss Limitations, Revised
- Relief for Non-Itemizers
- Employee Retention Credit
- Other Disaster Area Tax Issues
Most of us will always remember the year 2020, as much as we may like to forget it. On top of the COVID-19 emergency, street protests (both peaceful and not), and hotly contested election races, the U.S. has had numerous natural disasters – hurricanes, an unprecedented number of wildfires, severe windstorms, flooding, and what seems like everything except a plague of locusts (so far, the gigantic swarms of the insects that have invaded Africa and the Middle East haven’t made it across the Atlantic).
Congress typically passes legislation to provide some temporary tax relief to the victims of major disasters. Recently, Congress did just that when it passed the Taxpayer Certainty and Disaster Tax Relief Act of 2020, which the president signed on December 27, 2020. If you were a victim of one of the disasters covered by this bill, you may be interested to see if any of the tax benefits may be of help for you. First, a few definitions:
“Qualified disaster area” means any area in which a major disaster was declared by the president, during the period beginning on January 1, 2020, and ending on February 25, 2021, if the incident period of the disaster began on or after December 28, 2019 and on or before December 27, 2020. However, any area in which a major disaster was declared only because of COVID-19 is not included.
“Qualified disaster zone” is the portion of any qualified disaster area that the president, during the date parameters noted above, determined to warrant individual or individual and public assistance from the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act because of the qualified disaster in that disaster area.
“Incident period” means, with respect to any qualified disaster, the period specified by the Federal Emergency Management Agency (FEMA) as the period when a disaster occurred. (However, for the purposes of this act, that period shall not be treated as beginning before January 1, 2020, or ending after January 26, 2021.)
For a current listing of all affected areas and the dates of storms, floods, wildfires, and other disasters occurring in 2020 in federal disaster areas, go to https://www.irs.gov/newsroom/tax-relief-in-disaster-situations
Here are the highlights of the tax-relief measures included in the Taxpayer Certainty and Disaster Tax Relief Act of 2020:
Qualified Disaster Distributions – If you have sustained an economic loss because of a qualified disaster, you are allowed to withdraw from your eligible retirement plans – such as a 401(k) or 403(b) – and IRAs up to $100,000, less the aggregate amounts treated as qualified disaster distributions in prior years, without paying the 10% early-withdrawal penalty that applies if you are under age 59½. The distribution is still taxable, but if you choose to, the income from the qualified distribution can be spread over a three-year period beginning with the year of distribution, rather than you paying all of the tax in the distribution year.
Re-contribution Option – Further, you can re-deposit any amount of the qualified disaster distribution in one or more re-contributions over the three-year period beginning on the day after the date of the distribution. For example, let’s say you take a qualified disaster distribution of $30,000 from your IRA on Dec. 10, 2020, and opt to spread the tax over years 2020, 2021, and 2022 by including $10,000 of the distribution amount in each year’s return. In 2022, you are financially able to re-deposit the $30,000 to your IRA, which you do on Nov. 1, 2022. You would then need to amend your 2020 and 2021 returns to remove the $10,000 income from each year and claim a refund of the taxes paid on those parts of the distribution. None of the distribution would be reported on your 2022 return.
Waived 20% Withholding Requirement – Normally, 20% of a retirement plan distribution is withheld as income tax. This 20% withholding rule will not apply to a qualified disaster distribution.
Distribution Timing – Only distributions made on or after the first day of the incident period of a qualified disaster and before June 25, 2021, can qualify.
Special Rule for Individuals Affected by More Than One Disaster — The $100,000 limitation is applied separately to distributions made with respect to each qualified disaster.
Re-Contributing Withdrawals for Home Purchases – If you are under 59½, the general rule is that you’ll owe a 10% penalty on the taxable part of a distribution from an IRA (or an employer’s retirement plan). However, this 10% early-withdrawal penalty doesn’t apply to a distribution (lifetime maximum $10,000) from an IRA used by a first-time homebuyer to pay the qualified acquisition costs for a principal residence, if the funds are spent within 120 days of receiving the distribution. When disaster strikes, the taxpayer’s plans to purchase or construct a home sometimes are upended, and the funds from the withdrawal can’t be spent during the allotted time period.
To prevent the 10% penalty from kicking in when this happens, the act provides that any individual who received a qualified distribution during the period beginning 180 days before the first day of the incident period of a qualified disaster and ending 30 days after the last day of the incident period may make one or more contributions to an eligible retirement plan that total no more than the amount of the qualified distribution. The re-deposit must occur during the period beginning on the first day of the incident period of the qualified disaster and ending on June 25, 2021.
To qualify to make the recontribution, the amount distributed must have been intended to be used to purchase or construct a principal residence in a qualified disaster area but was not so used due to the qualified disaster in that area.
If the funds are re-contributed, then the taxpayer can amend their tax return for the year when the distribution was taxed for a refund of the taxes paid on the withdrawal.
Increased Limit on Retirement Plan Loans – Generally, a loan from a qualified employer plan to a participant or beneficiary is treated as a plan distribution unless the loan amount is at least the lesser of $50,000 or half of the present value of the employee’s nonforfeitable accrued benefit under the plan. An exception allows a loan up to $10,000 without regard to the accrued benefit rule – such a loan must be repaid within five years (longer repayment can be used for a principal residence plan loan).
The act eased the requirements for qualified individuals who sustained an economic loss because of the qualified disaster, by doing the following:
- Increasing the maximum amount a plan participant or beneficiary can borrow from a qualified employer plan from $50,000 to $100,000. The “half of present value” test was changed to “the present value of the nonforfeitable accrued benefit of the employee.”
- Allowing a longer repayment period, generally of one year.
To be eligible for this relaxation of the plan-loan rules, the individual’s principal place of abode at any time during the incident period of any qualified disaster must have been located within the qualified disaster area of the qualified disaster.
Loss Limitations Revised – Generally, to deduct a personal casualty or disaster loss, each event must be reduced by $100, and the overall loss must be reduced by 10% of the taxpayer’s adjusted gross income. The act modifies these rules by eliminating the 10% reduction and increasing the $100 reduction to $500.
Relief for Non-Itemizers – The personal casualty loss deduction is part of the itemized deductions claimed on Schedule A, so normally, a taxpayer who doesn’t itemize because their standard deduction is greater than the total of their itemized deductions won’t have any tax benefit from the casualty loss.
However, under the act, a taxpayer claiming a “net disaster loss” who does not itemize their deductions may add their “net disaster loss” to their standard deduction.
Employee-Retention Credit – The act provides an employee-retention credit for an employer that conducted an active trade or business in a qualified disaster zone at any time during the incident period of the qualified disaster AND when the trade or business became inoperable as a result of damage sustained because of the qualified disaster at any time during the period beginning on the first day of the incident period and ending on December 27, 2020.
The credit is 40% of the qualified wages of each eligible employee of the eligible employer for the taxable year. The amount of qualified wages for any individual is limited to no more than $6,000. As a result, the maximum credit is $2,400 per employee.
To be an eligible employee, the employee’s principal place of employment with the employer just before the qualified disaster must have been in the qualified disaster zone.
Qualified wages are wages paid by the employer starting when the trade or business became inoperable at the principal location where the employee was employed and through the date when the business resumed significant operations at the employee’s principal place of employment or, if earlier, 150 days after the last day of the incident period of the qualified disaster.
- Qualified wages include wages paid without regard to whether the employee performed no services, performed services at a different place of employment than their principal place of employment, or performed services at their principal place of employment before significant operations resumed.
- Qualified wages generally do not include wages paid to the employer’s relatives or wages that the employer uses in computing other tax credits, such as for the Work Opportunity Tax Credit, Research Credit, and others.
Other Issues – Briefly, here are a few other items that were already in the tax code that those affected by qualified disasters should be aware of:
Extended Deadlines – The IRS has the authority to postpone certain tax deadlines by up to one year for taxpayers affected by a federally declared disaster. Examples of deadlines the IRS will postpone in disaster areas include those for filing income, excise, and employment tax returns; paying income, excise, and employment taxes; and contributing to IRAs.
When to Claim Disaster Losses – Special rules apply to losses that occur in areas that the president declares eligible for federal disaster assistance. The losses must result from the disaster. The FEMA website lists the designated disaster areas. Taxpayers may elect to claim the loss
1. On the return for the year when it occurs, or
2. On the preceding year’s return (either the original or an amended return).
When to take the loss depends upon a number of factors and should be analyzed carefully to determine which year will be the most beneficial. Some of the factors to consider include the tax brackets for each year, the need for immediate cash, the effect on self-employment tax for those with business-disaster losses, and whether the loss will be used up against other income for the year. If the disaster loss is not fully used up in the year when it is first deducted, then it can create a net operating loss, which can be deducted on either a prior year or future year return (depending on which year the loss occurred).
Insurance Proceeds – A taxpayer whose principal residence (or its contents) is damaged in a disaster can qualify for special tax treatment regarding certain insurance proceeds received as a result of the casualty. To qualify, the residence must be located in a presidentially declared disaster area.
If you have been in a qualified disaster and have questions about the new provisions in the 2020 disaster legislation or want more information about the special tax rules for claiming disaster losses, please contact this office.