DON'T RUSH TO DEDUCT!

DON'T RUSH TO DEDUCT!

Monday, September 12, 2011

Many of the people who have experienced a large disaster event have two financial results.

1. The first is that insurance coverage is not enough to compensate for the loss or in some cases no insurance covers the event.

2. The second is the expected relief from tax deduction of a casualty loss to help fill the gap in insurance coverage.

These are normal patterns for people who are understandably angry and confused due to the stress caused by a huge personal loss suddenly coming upon them. One thing they know, they need professional assistance. They expect their tax preparation adviser to have the in-depth knowledge to advise them correctly as to how to proceed.

People who experience these events have a wish and a need. They wish they can get back into their home quickly and they need to find professionals that will help them get through the process of recovery. They assume that the person who has been assisting them file their tax returns is one professional that is ready to serve their needs. But, so often I see the results of bad professional advice. Providing bad or simply uninformed tax advice happens too frequently. Taking loss deductions that later have to be reversed is one of the most aggravating to me, also the most expensive to taxpayers. The potential and often very predictable reversal of that loss in two or three years will not be a happy situation for the taxpayer when it happens.

An important reminder for both taxpayers and tax advisers:
A loss is not deductible until both of two things have happened. The first is easy, the event must have occurred. That seems simple, but the second is less precise.

All the claims must be “settled.” Will the insurance pay full policy amounts? Will the insurance company reform the policy and pay over policy limits? Is there going to be a legal action against the insurance company or some other party that is responsible for the loss? Until all claims are settled there is no deduction. The loss is not established until the situation is settled or all remaining claims have been fully abandoned, a “closed transaction.”

In one recent case the taxpayer received tax benefits (reduction in tax liabilities) totaling $25,000 for the two years. Of course that money they “saved” on taxes may have been very useful to the taxpayer in those years, but when the taxpayer received substantial additional funds three years after the loss event. The taxpayer was facing a repayment of those tax benefits by reporting the prior loss as income in the year the additional proceeds were received.

But while the taxpayer had received the benefits at low tax rates, when those “benefits” turned around as income another disaster occurred. That income was added to all other income for that year. The $25,000 tax reductions became an additional tax bill of $45,000. Wow, $20,000 “implicit interest” on a $25,000 “interest free” loan from the tax authorities.

Be careful when you are told by your tax professional that you will not have to pay taxes because of the loss of your home as a result of the flooding, rain or fire that destroyed your home. You don’t need two disasters.

March 2014: New  Information

Additional Help for Taxpayers Recovering From a Catastrophic Loss

An organization with over twenty years experience assisting people who experience catastrophic event, United Policyholders (UP) offers many useful programs. If you need additional assistance and have not seen the  UP website, here is a link:

http://www.uphelp.org/sites/default/files/march2014_tipofthemonth.html

For a general link to the UP website use this link: http://www.uphelp.org/

All rights to reproduce or quote any part of the chapter in any other publication are reserved by the author. Republication rights limited by the publisher of the book in which this chapter appears also apply.

	JOHN TRAPANI
	Certified Public Accountant
	2975 E. Hillcrest Drive #403
	Thousand Oaks, CA 91362
	(805) 497-4411       E-mail John@TrapaniCPA.com
	Website:   www.TrapaniCPA.com
	Blog:  www.AccountantForDisasteRrecovery.com
	It All Adds Up For You

This material was contributed by John Trapani. A Certified Public Accountant who has assisted taxpayers since 1976, in analyzing and reporting transactions of the type covered in this material.  

Internal Revenue Service Circular 230 Disclosure

This is a general discussion of tax law. The application of the law to specific facts may involve aspects that are not identical to the situations presented in this material. Relying on this material does not qualify as tax advice for purpose of mounting a defense of a tax position with the taxing authorities

The analysis of the tax consequences of any event is based on tax laws in effect at the time of the event.

This material was completed on the date of the posting

© 2011, John Trapani, CPA