Weather Disasters in Indiana and Taxes

February 18, 2009

PAER-2009-3

George F. Patrick, Professor and Linda Ethridge Curry, Associate Faculty Member, Kelley School of Business IUPUI

Indiana suffered three weather‑related events in 2008 that resulted in federally declared (formerly presidentially declared) disaster declarations covering major portions of the state. Taxpayers in these areas may be eligible for some additional federal income tax deductions because Congress enacted legislation in October that provides new tax benefits for taxpayers who suffer losses in federally declared disaster areas during 2008 and 2009. The legislation involves two programs, with somewhat different provisions. However, each program provides special treatment for losses of property located in these disaster areas. As a further complication, individuals outside the specified disaster areas may qualify for increased higher education tax credits if they or their dependents attend a post‑secondary educational institution located in the Midwest (Heartland) disaster area.

Disaster Areas

 

Storms and flooding in January 2008 primarily affected northern Indiana. Twenty‑one counties were designated by the Federal Emergency Management Agency (FEMA) for assistance to individuals in FEMA‑1740‑DR, Indiana Major Disaster Declaration, originally issued January 30, 2008, and last updated May 20, 2008. Maps showing disaster areas are available on the web at http://www.fema.gov/news/disasters.fema. The Indiana counties designated for individual assistance in the January disaster area are Allen, Benton, Carroll, Cass, DeKalb, Elkhart, Fulton, Huntington, Jasper, Kosciusko, Lake, LaPorte, Marshall, Newton, Noble, Pulaski, Stark, St. Joseph, Tippecanoe, White, and Whitley.

The June storms and flooding that affected central and southern Indiana are included in the Midwest (Heartland) disaster area that comprises parts of ten states. The Indiana counties are identified in FEMA‑1766‑DR, initially issuedJune 8, 2008, and last amended on August 8, 2008. The counties designated for individual assistance in this disaster area are Adams, Bartholomew, Brown, Clay, Daviess, Dearborn, Decatur, Gibson, Grant, Greene, Hamilton, Hancock, Hendricks, Henry, Huntington, Jackson, Jefferson, Jennings, Johnson, Knox, Lawrence, Madison, Marion, Monroe, Morgan, Owen, Parke, Pike, Posey, Putnam, Randolph, Ripley, Rush, Shelby, Sullivan, Tippecanoe, Vermillion, Vigo, Washington, and Wayne. Ten other counties (Benton, Boone, Fountain, Franklin, Jay, Montgomery, Ohio. Switzerland, Union, and Wabash) qualify only for limited public assistance.

The September storms and flooding that affected northwestern and southern Indiana are covered in FEMA‑1795‑DR, originally issued on September 23, 2008, and most recently amended on November 7, 2008. The affected counties are Clark, Crawford, Daviess, Dearborn, Decatur, Dubois, Fayette, Floyd, Franklin, Gibson, Harrison, Jackson, Jasper, Jefferson, Jennings, Knox, Lake, LaPorte, Lawrence, Martin, Ohio, Orange, Perry, Pike, Porter, Posey. Ripley, Rush, Scott, Spencer, St. Joseph, Switzerland, Union, Vanderburgh, Washington, Warrick, and Wayne.

Federal Income Tax Legislation

The Emergency Economic Stabilization Act (EESA), which was enacted in October 2008, modifies the federal income tax procedures for deducting losses and expenses incurred in most federally declared disasters occurring in 2008 and 2009. The January and September storms and flooding in Indiana are covered by these pro‑ visions. Different rules apply to tax‑ payers affected by the June storms and flooding because the EESA extended a number of the Hurricane Katrina and Gulf Opportunity Zone provisions to the ten‑state Midwest (Heartland) disaster area. These special provisions apply only to taxpayers in the Midwest counties declared federal disaster areas as a result of storms and flooding occurring in May through August 2008, and these taxpayers are not eligible to claim the national disaster relief tax benefits. The following discussion summarizes the provisions likely to be most important for many taxpayers.

National Disaster Relief

The new national disaster relief rules, which apply to January and September 2008 disasters in Indiana, increase the potential deduction for losses of personal‑use property. An individual’s net disaster loss is the excess of his or her personal casualty losses attributable to the disaster minus any personal casualty gains. The net disaster loss is not subject to the 10 percent of adjusted gross income (AGI) limit that is generally applicable on Form 4684, Casualties and Thefts. In addition, a qualifying taxpayer can deduct a net disaster loss even if he or she is not itemizing deductions, because the individual’s standard deduction can be increased by the amount of the net disaster loss. Any portion of a casualty loss that is not a disaster loss is still deductible only as an itemized deduction, after reduction by 10 percent of the taxpayer’s AGI. All losses are subject to the $100 reduction, which is increased to $500 for 2009 losses.

A taxpayer may also deduct as a qualified disaster expense some costs incurred in a trade or business that would otherwise be capitalized. This includes expenditures paid or incurred to:

  1. abate or control hazardous substances;
  2. remove debris from, or demolish structures, on real property; and
  3. repair business property damaged as a result of the federally declared disaster.

Additional first‑year depreciation equal to 50 percent of the adjusted basis of qualified replacement property is also available. Qualified property is MACRS property with a recovery period of 20 years or less, as well some nonresidential real property and residential rental property, that rehabilitates or replaces property that was damaged, destroyed, or condemned as a result of the federally declared disaster. Substantially all of the replacement property’s use must be in the active conduct of a trade or business in the designated disaster area. Although used property may qualify, original use of the property in the disaster area must start with the taxpayer. The purchase and placed‑in‑service period to qualify for this provision begins on the date of the disaster and ends on December 31 of the third calendar year following the date of the disaster (the fourth year for real property).

A five‑year carryback period is provided for qualified disaster net operating losses (NOLs) occurring in 2008 and 2009. This compares with a three‑year carryback period for many other NOLs. The disaster loss NOL is limited to the taxpayer’s total NOL for the year. For a fuller discussion of these provisions see IRS Publication 547, “Casualties, Disasters and Thefts,” available at www.irs.gov.

Midwest Disaster Relief

Several individual tax relief provisions associated with Hurricane Katrina and the Gulf Opportunity Zone were extended to disasters occurring between May 2 and August 1, 2008, in Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin. The IRS issued Publication 4492‑B, “Information for Affected Taxpayers in the Midwest Disaster Area,” in January 2009 to explain these provisions, which include relaxation of the retirement plan distribution rules. It is available at www.irs.gov.

The deduction for personal‑use property losses incurred in the Midwest disaster area is not subject to either the $100 or the 10 percent of AGI limitations that generally apply to personal casualty and theft losses. However, these losses do not increase the taxpayer’s standard deduction. Thus, taxpayers must itemize deductions to deduct Mid‑ west disaster area casualty losses of personal‑use property.

Midwest disaster area business loss provisions are similar to the national disaster relief provisions for the additional first‑year depreciation of qualifying replacement property and NOL allowances and carrybacks. Environmental remediation costs resulting from the disaster are fully deductible, but businesses may deduct only half of their demolition and debris cleanup costs—the other half must be capitalized. The replacement period for postponing gain on property destroyed in the disaster is five years after the year any gain is realized. Employers who continued to pay their employees while their businesses were inoperable are eligible for a wage credit.

Education Credits

The Hope and lifetime learning credits are doubled for 2008 and 2009 for individuals attending eligible educational institutions in Midwest disaster area counties designated for individual assistance. The location of the taxpayer’s principal residence is not a factor for the increased credit: All that matters is that the student be attending an eligible post‑secondary educational institution that is located in a designated county in any of the ten states.

  1. The Hope credit for 2008 generally is 100 percent of the first $1,200 of qualified higher education expenses and 50 percent of the next $1,200 of qualified education expenses, for a maximum credit of $1,800. Both $1,200 figures are doubled, to $2,400, for students attending an eligible school in a Midwest disaster area county, so that the maximum credit becomes $3,600.
  2. For the lifetime learning credit, the limit is 40% (rather than 20%) of up to $10,000 of qualifying expenses.

The definition of qualified expenses for both credits is expanded from just tuition and fees required for enrollment to include books and supplies and, for those attending on at least a half‑time basis, room and board. The regular income limits for phase‑out of the education credits still apply.

Summary

Many counties in Indiana were declared disaster areas in 2008 and many taxpayers may be eligible for special treatment of personal casualty losses and business losses. The new laws have significantly different provisions, depending on which disaster declaration is involved. Individuals who attend institutions of higher education in disaster areas may qualify for increased education credits. Review your situation carefully to determine if you can take advantage of the recent disaster‑related tax legislation. Further information is available at the IRS website www.irs.gov. Seek competent professional assistance if you are uncertain how to proceed.

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