Jim de Bree: Hurricanes, quakes and tax reform

Jim de Bree
Jim de Bree
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Many of my former business partners moved to Florida when they retired. The most popular community for those partners is Naples.

When Hurricane Irma devastated Florida in general last week, and Naples in particular, my thoughts and prayers were with my retired colleagues who live there.

After talking to several of them and hearing more through our retired partners’ network, I learned that, fortunately, none of them was injured. However, most suffered extensive damage to their homes.

It reminds me of what it was like to live a mile from the epicenter of the Northridge earthquake in 1994.

One of my colleagues mentioned that at least he would get to write the casualty loss off on his taxes this year. That got me thinking about a serious implication of proposed tax reform that has received little public attention.

House Speaker Ryan, the principal spokesman for the Republican tax reform efforts, has called for the elimination of all itemized deductions except for home mortgage interest and charitable contributions. Of the deductions that would be eliminated, only the one for state and local taxes has received much attention.

However, right in the middle of the IRS schedule on which a taxpayer claims itemized deductions is the deduction for those who have sustained a casualty loss. If your property is damaged or destroyed by a calamity such as a fire, storm or earthquake, you can deduct a portion of your loss.

While the rules are somewhat complex, generally you can deduct a portion of the loss that is not covered by insurance. For most taxpayers, the deduction is generally the excess of repair costs over the amount reimbursed by insurance.

To ensure that only major losses are deducted and that the tax benefit is limited to those who are not extremely wealthy, losses are only deductible to the extent they exceed 10 percent of an individual’s economic income in the year of the loss.

In a major casualty that occurs in a presidentially declared disaster area, taxpayers can claim the loss by filing an amended tax return for the previous year to accelerate receipt of a tax refund.

From a policy perspective, the casualty loss deduction is a way to promptly get federal aid to taxpayers who need it when insurance is unavailable.

The process does not require the formation of a new bureaucracy to administer the benefits, and the procedures are subject to review by the IRS examination division.

If the casualty loss deduction is repealed, the streamlined process for aiding taxpayers who suffered a significant casualty will disappear.

One of the arguments for repealing the deduction is simplification. In this case, we might be doing nothing more than replacing tax complexity with an increased role by FEMA that will hopefully accomplish the same thing, but likely at a greater administrative cost.

Casualty losses are rarely claimed by taxpayers; therefore, repealing the deduction does not reduce the complexity of their return for most taxpayers.

Then there is the argument that we don’t want to subsidize the behavior of people who choose to live in dangerous areas. Those who argue this position may question why the government should subsidize crazy Californians living in seismically active areas or people who live near the Atlantic and Gulf coasts who periodically suffer from hurricanes. What about people in the Midwest who suffer tornado losses or those who live in areas prone to fires?

The simple truth is that, no matter where you live, periodic catastrophic events are a fact of life, and use of the tax system to assist unfortunate taxpayers has proven effective.

Over the past quarter century, it has become extremely difficult to effectively insure against risks such as earthquakes or hurricanes. The insurance premiums are expensive and the deductibles are high.

Consequently, taxpaying Americans have been forced to bear a greater amount of risk related to catastrophic events.

At the end of the month, the Trump administration is going to release its tax reform proposals. While details of the plan are sketchy to date, the administration is seeking to dramatically reduce tax rates.

Those rate reductions can only be accomplished if many deductions are eliminated. Whether the Treasury Department will go along with Speaker Ryan’s itemized deduction proposals is uncertain at this time.

If the casualty loss deduction is repealed, California homeowners will have to re-evaluate their earthquake insurance needs because there will no longer be tax assistance for uninsured losses.

My colleagues in Florida are hoping that any repeal of the casualty loss deduction will not be retroactive.

This clearly is an issue that has received little attention to date, but if proposed, it will require further vetting before tax law changes are implemented.

Jim de Bree is a retired CPA who resides in Valencia.

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