HOW CAN A NATURAL DISASTER TURN INTO A FINANCIAL DISASTER?

HOW CAN A NATURAL DISASTER TURN INTO A FINANCIAL DISASTER?

Your tax professional may not be an expert in dealing with a disaster income tax loss claim, or a gain that may cost you thousands of dollars in unnecessary tax liabilities!

 

When casualty / disaster losses strike, CPA’s want to be helpful to their clients. It is a traumatic time for the client. The CPA is a steady minded adviser, seen by the client as an expert in all things “tax.” The truth is that less than .5% of tax returns claim a casualty loss. The average loss claimed is about $20,000. What does this tell you? Most likely, your normal tax preparer has no experience dealing with the intricacies and potential pitfalls of properly reporting a casualty loss. In fact a large loss of over $100,000 probably shows up on less than 1 in 1,000 tax returns. In my first 27 years of practice I had only one client who experienced a casualty loss. In the last 22 years I have helped many clients, annually, throughout the nation who have experienced a major casualty / disaster loss.

Many of the cases that I have been called in to assist have been “fixing” returns prepared by other tax preparers. It would have been better if the taxpayer had sought my help first.

As a taxpayer who is looking for assistance, you may be eligible for a casualty loss claim. You may also find out that you have an unexpected gain.  The gain may not be apparent for a year or two. The unexpected gain may be exempt from any taxation or it may be possible to delay the taxation of the gain for years.

A casualty loss is the tax result of “damage, destruction, or loss of physical property resulting from an identifiable event that that you were powerless to prevent and it occurred suddenly, and was unexpected and unusual.” If insurance compensation is available, the insurance claim must be processed before claiming any loss that may result from a loss in excess of the insurance proceeds.

Taxpayers whose damaged property is located in a region designated as a Federal Disaster Area may be eligible for special tax relief provisions.

Some CPA’s may go too far. One of the worst things a tax preparer can do for a client is “create” a loss deduction that is not supported by the facts. Some of those facts may not be evident as part of a quick cursory analysis.  When a casualty loss is claimed that is not justified, and the IRS audits that loss, the client will be subjected to denial of the deduction, repayment of taxes, interest charges and penalties.

Remember, the amount you save in taxes as a result of claiming a casualty loss will never equal the economic loss that you realized. The best defense, the best strategy is adequate insurance coverage. Unfortunately many insurance companies under-insure their customers, sometimes, in order to sell the policy based on a premium cost expectation of the client. Not all policies are the same, not all premiums are the same.

Any loss that you claim on a tax return will be subjected to legal limitations and the remaining loss will only be a deduction on your return not a “payment” or “credit” from the IRS for the amount of the loss. The greater your pre-loss taxable income is, the greater the “value” of the deduction.

The preparation of tax returns that include a casualty loss must be looked at differently. Most “normal” returns are much like a “scrap book” for the year of your financial life; W-2’s, 1099’s, mortgage interest 1098’s, etc. All of these are static fixed amount forms. They are snapshots for the year’s income and expenses. But, a casualty loss involves a situation that will likely impact your tax return for many years. While the normal tax return may be a “scrap book,” casualty loss reporting is more like “producing” a movie that spans multiple years. Given that situation, it is important, when preparing the return, to “play the movie to the end of the real.” Yes, the subsequent years are projections, but if they are not considered, a new disaster can develop. You can’t just put numbers down on a tax return for the year without considering how the situation is going to “play out over the next several years.” If you don’t understand how things may occur next year or even two years from now, you will likely make bad decisions today. Those bad decisions will likely cost you dearly in the future.

The tax law in this area is very empathetic towards taxpayers. But, if you don’t follow the rules very precisely, you will likely make a costly error.

I offer you a free 30 minute analysis consultation that will determine how you should proceed. Maybe your CPA understands the situation and will get you through the process. Maybe the CPA understands the law, but is not able to properly report the situation on a return. If you need my services maybe I can work with your tax preparer or maybe I need to prepare the whole return for you. All it will cost you, initially, is 30 minutes.

	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
	It All Adds Up For You

WHY USE A SPECIALIST FOR DISASTER INCOME TAX REPORTING?

WHY USE A SPECIALIST FOR DISASTER INCOME TAX REPORTING?

Most tax professionals may never prepare a “Disaster Income Tax Return.” Seek out a knowledgeable tax professional who has years of experience providing disaster income tax reporting services!

The catastrophic disaster event has destroyed or damaged your home!  You have many new responsibilities to accomplish while maintaining a life, a family, a job. One of the responsibilities is dealing with the income tax consequences including the tax reporting. The rules can be complicated to understand and comply with. The IRS publication seems easy, but what is not included. You have no experience dealing with these rules. These events seem to be occurring more often, yet not only do you have no experience dealing with the tax aspect, your tax professional also lacks the experience and deep understanding needed to navigate the requirements. There is a lot of money at risk. If you don’t get it right, the IRS audit could cost you a lot of money (additional taxes, interest and penalties) putting your family’s security at risk. This is money you need to repair/rebuild you home.

You call your insurance company. You determine that the coverage is not enough . You contact a contractor, you call you mortgage lender, you arrange to have the debris removed. Is there asbestos to be dealt with? Then you wonder about the income tax consequences. In any major casualty, one of the first calls should be to a tax professional who deals with these event all the time; there are many tax responsibilities that need immediate attention.

You call the income tax professional you have relied on for years. The professional tells you he/she will assist you with the income tax consequences. But did you ask what experience he/she has reporting these events? What should you do immediately? Probably, you don’t ask. You have too many other responsibilities and you have dealt with your tax professional for years. In fact, of all the skilled professionals you now need, your tax professional is the only one with whom you have an existing relationship. It seems like this part is under control.

But it is probably not under control.

In some areas of the country many, professionals have experience dealing with the tax reporting of a disaster because annually a tornado or hurricane comes through the area.

But then there is the old “saw:”

“Lighting doesn’t strike twice in the same place.”

Often the tornado is nearby even if it is not your home that is affected this time. Even in these areas of high recurrence, a particular tax professional may only deal with a disaster event once every four or five years.

Some income tax reporting responsibilities like a disaster are unique or at least rare. Let’s compare this situation to a situation that you may be more familiar with.

You own a car.

Sometime in your many years of owning a car you have changed the oil, replaced windshield wiper blades or checked the tire pressure. But, when the check engine light starts flashing you quickly get the car to a mechanic that you trust will diagnosis the problem. Maybe it is easy or maybe you need a new head gasket; a difficult situation that you are not going to tackle yourself. The mechanic has the tools, the skills and the experience to deal with the situation.

What do you do when the problem is the transmission? Most likely, your trusted mechanic will tell you that special tools may be needed. There are so many manuals for different transmissions. The shop isn’t called on to repair a transmission often enough to make it efficient to have the repair manuals, the tools or the expertise for transmissions. Your mechanic sends you to a transmission specialist who has the expertise, the tools and the manuals to assist you with your transmission repair.

What, you ask, does this have to do with disaster income taxes?

Let’s compare the situations…

For many simple income tax returns, taxpayers prepare their own income tax forms, like changing the oil or they may have a professional do the work. Once the tax return becomes more complicated and seems beyond simple preparation knowledge, taxpayers develop ongoing relationships with a tax professional who demonstrates they have the knowledge to prepare the taxpayer’s returns. These situations usually involve ongoing tax reporting of investments, rentals, farming operations, large charitable contributions, small businesses, employee expenses, deferred compensation, and more. The tax professional will often be involved in tax planning to help the taxpayer deal with their tax responsibilities very efficiently. But when you have a disaster recovery situation, what are the odds that your tax professional will have the specialized knowledge to assist you with the proper reporting, including using the benefits built into the tax law provides for these events?

A 2014 Pew Trust study states:

“All told, up to 1.2 million tax preparers make a living deciphering the labyrinth U.S. tax code for taxpayers. The IRS reported 63 percent of all returns were done by tax preparers in 2013 and estimates are that about half were filed by unregulated preparers.”

The study determined that “many of the small, independent tax preparers are subject to no standards at all.” For these income tax preparers there are no standards of professional competence they must adhere to.

In 2011 approximately 141,000 tax returns were filed claiming a casualty loss. The average loss claimed was $22,000. This average was about the same for 2005, the year of the Hurricane Katrina disaster. The number of forms claiming a casualty loss deduction for 2005 was about 819,000. Assuming that 2011 was a normal year and that the number of income tax preparers for 2011 was similar to 2013, 1.2 million, there is about a 10% chance that a tax preparer will have a casualty loss claim in any one year to report. To this situation add the fact that the average casualty loss for 2011 was $22,000. Many of the losses claimed were quite small. Where a disaster loss is involved the deductible loss is likely to be substantially greater than $22, 000. The average includes small casualty losses  under $22,000, as well as some losses of over $100,000 or $500,000. There is a very small chance that an individual income tax preparer will see a casualty loss claim in any one year or even in a life-time. It is also probable that in any one year there are going to be income tax preparers who have more than one client who has a casualty loss claim as disasters result in a cluster of losses. You can conclude that in many areas of the country it is likely that an individual income tax preparer may spend a career not having to prepare a tax return that includes a significant disaster loss claim. I can testify that for the first 9 years of my professional career, I had no experience with a casualty loss of any kind. In my first 27 years of practice only one client had a significant casualty loss.

IRS Statistics for 2005 and 2011

Number of Returns With Itemized Deductions )	Casualty or Theft Loss Deductions
	Total Number of Returns Filed	Total Amount (000)	Average Loss Claimed
2011: 46,293,834	(.3%) 140,717	$3,180,912	$22,600
2005: 47,755,427	(1.7%) 813,976	$14,984,169	$18,400

After the 1994 Northridge Earthquake that rocked the San Fernando Valley area of Los Angeles in January, damaging several hundred thousand homes, I had the opportunity to spend months prior to the 1994 filing season that started in in January 1995, preparing for the tax returns that would be reporting the income tax consequences of the disaster. Once I had developed that specific knowledge to sereve taxpayer after the 1994 earthquake, I decided that it was an area of the tax law that I could concentrate on, helping taxpayers in other disasters.

Over the years I have had the opportunity to correct returns filed by other tax preparers, often saving the taxpayers tens of thousands of dollars in taxes.

Like the “transmission specialist,” whose business is often dependent on referrals from auto mechanics, knowledgeable income tax professionals call on my firm to assist their clients with the details of reporting a disaster while retaining the preparation of the rest of the tax return themselves, maintaining the ongoing  relationship with their client. This way the client has the best of service, the basic return is prepared by a tax preparer who has the ongoing service relationship while the disaster reporting is handled by our firm in an efficient manner consistent with observing the special tax laws related to reporting a disaster event.

These tax professionals don’t want to learn all the details necessary to properly report a client’s disaster reporting situation. The client gets the benefit of having an experienced professional make sure that the income tax consequences of the disaster are reported properly. The income tax professional saves learning time for reporting an event that they may never have to deal with ever again.

Questions to ask your income tax professional

1.                  Have you prepared any income tax returns reporting a disaster?

My Answer:

I have prepared disaster loss returns for taxpayers in California (fires and earthquake), East Coast (hurricanes), Mid-west (fires and floods).

2.                  How much time do you spend, annually, maintaining the special knowledge related to reporting a disaster on an income tax return?

My Answer:

Although I have spent over 22 years concentrating on this area of the tax law, I spend over 100 hours per year maintaining and updating my knowledge. The IRS and courts are always issuining out new interpretations or sustaining and solidifying existing rules.

3.                  What services do you provide to the community related to preparing for a disaster?

My Answer:

I have prepared a concise Disaster Preparation Guide for taxpayers, if implemented, will reduce the stress of experiencing a disaster event.

I have materials that are continually revised for presentation to taxpayer community groups consisting of those who have experienced a disaster. I don’t charge for my time for these meetings.

There is a lot of information on this blog that I have developed over the past eight years.

Taxpayers can view a video of a presentation I made in Colorado in February 2014. It can be viewed by Googling or searching YouTube for “Post Disaster Income Issues.”

4.                  Have you personally experienced a disaster loss?

My Answer:

My life was totally changed as a result of the January 17, 1994, Northridge Earthquake.

5.                  What types of losses have you reported for taxpayers?

My Answer:

Earthquakes, Fires, Floods, Hurricanes

6.                  Is your tax preparer willing to work with a knowledgeable CPPA to be confident that your disaster situation is being reported properly?

Your Tax Preparer’s Answer: