Checkpoint Special Study: Tax Provisions in the 2017 Disaster Tax Relief Bill

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1 Checkpoint Special Study: Tax Provisions in the 2017 Disaster Tax Relief Bill On September 29, President Trump signed into law P.L , the Disaster Tax Relief and Airport and Airway Extension Act of The Act, which had been passed by Congress the day before, provides temporary tax relief to victims of Hurricanes Harvey, Irma, and Maria. Businesses that qualify for relief may claim a new employee retention tax credit of up to $2,400 for qualified wages paid to eligible employees. Relief for individuals includes, among other things, loosened restrictions for claiming personal casualty losses, tax-favored withdrawals from retirement plans, and the option of using current or prior year's income for purposes of claiming the earned income and child tax credits. Eased Casualty Loss Rules Current law. A taxpayer generally may claim a deduction for any loss sustained during the tax year and not compensated by insurance or otherwise. (Code Sec. 165(a)) For individuals, a personal loss from a casualty is deductible only to the extent that (1) it exceeds $100, and (2) all casualty losses (after application of the $100-floor) for the tax year exceed 10% of adjusted gross income (AGI). (Code Sec. 165(h)) If the disaster occurs in a federally declared disaster area, the taxpayer may elect to take into account the casualty loss in the tax year immediately preceding the tax year in which the disaster occurs. (Code Sec. 165(i)) The deduction for casualty losses is an itemized deduction. New law. The Act provides relief in a number of ways to taxpayers that suffer a net disaster loss (below) for any tax year. Net disaster loss. The Act defines a net disaster loss as the excess of qualified disaster-related personal casualty losses over personal casualty gains, as defined in Code Sec. 165(h)(3)(A). Qualified disaster-related personal casualty losses, in turn, are losses described in Code Sec. 165(c)(3) which arise:... in the Hurricane Harvey disaster area (see below for the distinction between areas and zones ) on or after Aug. 23, 2017, and which are attributable to Hurricane Harvey;... in the Hurricane Irma disaster area on or after Sept. 4, 2017, and which are attributable to Hurricane Irma; or... in the Hurricane Maria disaster area on or after Sept. 16, 2017, and which are attributable to Hurricane Maria. (Act Sec. 504(b)(3)) For purposes of the Act, a disaster zone means the portion of the disaster area determined by the President to warrant individual or individual and public assistance from the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of the disaster. A disaster area 1

2 means an area with respect to which a major disaster has been declared by the President by reason of the disaster. (Act Sec. 501(a)) 10% limitation removed. For taxpayers claiming a net disaster loss, the Act eliminates the current law requirement that personal casualty losses must exceed 10% of AGI to qualify for a deduction. (Act Sec. 504(b)) Relief available to non-itemizers. The Act also eliminates the current law requirement that taxpayers must itemize deductions to access this tax relief for losses it does so by increasing an individual taxpayer's standard deduction under Code Sec. 63(c) by the net disaster loss. (Act Sec. 504(b)(1)(C)) No reduction for taxpayers subject to AMT. The Act provides that Code Sec. 56(b)(1)(E), which generally disallows the standard deduction for alternative minimum tax (AMT) purposes, does not apply for the portion of the standard deduction attributable to the net disaster loss. (Act Sec. 504(b)(1)(D)) Increased floor. In addition, the Act increases the $100 per-casualty floor to $500 for qualified disaster-related personal casualty losses. (Act Sec. 504(b)(1)(B)) Eased Access to Retirement Funds Current law. A loan from a qualified employer plan to a participant or beneficiary is treated as a plan distribution unless, among other things: (i) the loan amount doesn't exceed the lesser of: (A) $50,000, or (B) half of the present value of the employee's nonforfeitable accrued benefit under the plan (however, a loan up to $10,000 is allowed, even if it's more than half the employee's accrued benefit) (Code Sec. 72(p)(2)(A)); and (ii) the loan is required to be repaid within five years, (Code Sec. 72(p)(2)(B)(i)) except that a longer repayment can be used for a principal residence plan loan. (Code Sec. 72(p)(2)(B)(ii)) Early (generally, pre-age 59 1/2) withdrawals from a qualified retirement plan result in regular tax plus an additional tax equal to 10% of the amounts withdrawn that are includible in gross income. (Code Sec. 72(t)(1)) The additional tax applies unless the taxpayer qualifies for one of several specific exceptions. (Code Sec. 72(t)(2); Code Sec. 72(t)(3)) New law. The Act eases a number of rules to allow victims to make qualified hurricane distributions (below) from their retirement plans of up to $100,000 (less any prior withdrawals treated as qualified hurricane distributions ; Act Sec. 502(a)(2)(A)). Qualified hurricane distribution. The Act defines a qualified hurricane distribution as any distribution from an eligible retirement plan, as defined in Code Sec. 402(c)(8)(B) (which includes IRAs), made: 2

3 ... on or after Aug. 23, 2017, and before Jan. 1, 2019, to an individual whose principal place of abode on Aug. 23, 2017, is located in the Hurricane Harvey disaster area and who has sustained an economic loss by reason of Hurricane Harvey;... on or after Sept. 4, 2017, and before Jan. 1, 2019, to an individual whose principal place of abode on Sept. 4, 2017, is located in the Hurricane Irma disaster area and who has sustained an economic loss by reason of Hurricane Irma; and... on or after Sept. 16, 2017, and before Jan. 1, 2019, to an individual whose principal place of abode on Sept. 16, 2017, is located in the Hurricane Maria disaster area and who has sustained an economic loss by reason of Hurricane Maria. (Act Sec. 502(a)(4) Penalty relief. Significantly, the Act excepts qualified hurricane distributions from the 10% early retirement plan withdrawal penalty. (Act Sec. 502(a)(1)) Eased inclusion rules: The Act allows taxpayers to spread out any income inclusion resulting from such withdrawals over a 3-year period, beginning with the year that any amount is required to be included (or elect out). (Act Sec. 502(a)(5)) Favorable recontribution rule. The Act also allows the amount distributed to be re-contributed at any time over a 3-year period beginning on the day after the distribution was received. (Act Sec. 502(a)(3)(B)) If re-contributed to a eligible retirement plan other than an IRA, the taxpayer is treated as having received the qualified hurricane distribution in an eligible rollover distribution (as defined in Code Sec. 402(c)(4)) and as having transferred the amount to an eligible retirement plan in a direct, trustee-to-trustee transfer within 60 days of the distribution. (Act Sec. 502(a)(3)(B)) If recontributed to an IRA, the qualified hurricane distribution is treated as a Code Sec. 408(d)(3) distribution that is transferred to an eligible retirement plan in a direct trustee to trustee distribution within 60 days of the distribution. (Act Sec. 502(a)(3)(C)) The net effect is that a timely recontribution will allow the taxpayer to recoup the tax he paid on the qualified hurricane distribution (or avoid it entirely if the repayment is made in the same year as the distribution). For example, if a plan participant receives a qualified hurricane distribution in 2017 he will pay regular tax on it (spread out over 3 years) but not the 10% penalty tax. If he recontributes the qualified hurricane distribution amount in 2018, he may file an amended return and get a refund of the tax he paid on his 2017 return for the distribution. No withholding. For purposes of the withholding rules under Code Sec. 3405, qualified hurricane distributions aren't treated as eligible rollover distributions (which, unless certain requirements are met, are otherwise subject to 20% withholding under Code Sec. 3405(c)(1)(B)). (Act Sec. 502(a)(6)(A)) 3

4 Relief for cancelled home purchases, etc. The Act also allows for the recontribution of certain retirement plan withdrawals for home purchases or construction, which were received after Feb. 28, 2017 and before Sept. 21, 2017, where the home purchase or construction was cancelled on account of Hurricane Harvey, Irma, or Maria. (Act Sec. 502(b)) A timely recontribution avoids tax on the plan withdrawal. The recontribution must be made during the period beginning on Aug. 23, 2017, and ending on Feb. 28, Eased rules for retirement plan loans. With respect to retirement plan loans, the Act:... increases the maximum amount that a participant or beneficiary can borrow from a qualified employer plan under Code Sec. 72(p)(2)(A), from $50,000 to $100,000; (Act. Sec. 502(c)(1))... removes the one half of present value limitation; (Act Sec. 502(c)(1)) and... allows for a longer repayment term, if the due date for any repayment with respect to the loan occurs during a qualified beginning date that is Hurricane-specific and ends on Dec. 31, 2018, by delaying the due date of the first repayment by one year (and adjusting the due dates of subsequent repayments accordingly). (Act Sec. 502(c)(2)(A)) Charitable Deduction Limitations Suspended Current law. An individual who itemizes can deduct charitable contributions up to 50%, 30% or 20% of AGI, depending on the type of property contributed and the type of donee). (Code Sec. 170(b)(1)) A corporation generally can deduct charitable contributions up to 10% of its taxable income. (Code Sec. 170(b)(2)) Amounts that exceed the ceilings ( excess contributions ) can be carried forward for five years by both individuals and corporations, subject to various limitations and ordering rules. (Code Sec. 170(d)) For individuals, charitable contributions are deductible only as an itemized deduction. (Reg A-1(a)) New law. For qualifying charitable contributions associated with qualified hurricane relief, the Act:... temporarily suspends the majority of the limitations on charitable contributions in Code Sec. 170(b);... provides that such contributions will not be taken into account for purposes of applying Code Sec. 170(b) and Code Sec. 170(d) to other contributions;... provides eased rules governing the treatment of excess contributions; and 4

5 ... provides an exception from the overall limitation on itemized deductions for certain qualified contributions. Qualified contributions must be paid during the period beginning on Aug. 23, 2017, and ending on Dec. 31, 2017, in cash to an organization described in Code Sec. 170(b)(1)(A), for relief efforts in the Hurricane Harvey, Irma, or Maria disaster areas. (Act Sec. 504(a)(4)) Qualified contributions must also be substantiated, with a contemporaneous written acknowledge that the contribution was or is to be used for relief efforts (Act Sec. 504(a)(4)(A)(ii)), and the taxpayer must make an election for Act. Sec. 504(a) to apply. (Act Sec. 504(a)(4)(A)(iii) For partnerships and S corporations, the election is made separately by each partner or shareholder. (Act Sec. 504(a)(4)(C)) Employee Retention Tax Credit for Employers Current law. Certain business incentive credits are combined into one general business credit (GBC) for purposes of determining each credit's allowance limitation for the tax year. A GBC (claimed on Form 3800) is allowed against income tax for a particular tax year and equals the sum of: (1) the business credit carryforwards carried to the tax year, (2) the current year GBC, and (3) the business credit carrybacks carried to the tax year. (Code Sec. 38(a)) A list of the component credits of the current year business credit is provided in Code Sec. 38(b). New law. The Act provides a new employee retention credit for eligible employers affected by Hurricanes Harvey (Act Sec. 503(a)), Irma (Act Sec. 503(b)), and Maria (Act Sec. 503(c)). Eligible employers are generally defined as employers that conducted an active trade or business in a disaster zone as of a specified date (for Hurricane Harvey, Aug. 23, 2017; Irma, Sept. 4, 2017; and Maria, Sept. 16, 2017), and the active trade or business of which was, on any day between the specified date and Jan. 1, 2018, rendered inoperable as a result of damage sustained by the hurricane. In general, the credit is be treated as a credit listed in Code Sec. 38(b), and equals 40% of up to $6,000 of qualified wages with respect to each eligible employee of such employer for the tax year. Thus, the maximum credit per employee is $2,400 ($6,000 40%). Employer X is an eligible employer in the Hurricane Harvey disaster zone. X has two eligible employees, A and B, to whom X pays qualified wages of $4,000 and $7,000 respectively. X is entitled to a total credit of $4,000; $1,600 for the wages paid to A ($4,000 40%) and $2,400 for $6,000 of the wages paid to B ($6,000 40%). 5

6 An eligible employee with respect to an eligible employer is one whose principal place of employment with the employer was in Hurricane Harvey, Irma, or Maria disaster zone as of the respective date above. Qualified wages mean wages (as defined in Code Sec. 51(c)(1) but without regard to Code Sec. 3306(b)(2)(B)) paid or incurred by an eligible employer with respect to an eligible employee on any day after the specified date (above) and before Jan. 1, 2018, which occurs during the period: (i) beginning on the date on which the employer's trade or business first became inoperable at the principal place of employment of the employee immediately before the respective hurricane, and (ii) ending on the date on which such trade or business has resumed significant operations at such principal place of employment. Qualified wages include wages paid without regard to whether the employee performs no services, performs services at a different place of employment than such principal place of employment, or performs services at such principal place of employment before significant operations have resumed. Limitations. An employee can not be taken into account more than one time for purposes of the employee retention tax credit. So, for instance, if an employee is an eligible employee of an employer with respect to Hurricane Harvey for purposes of the credit, the employee cannot also be an eligible employee of the employer with respect to Hurricane Irma or Hurricane Maria. (Act Secs. 503(a)(4), (b)(4), and (c)(4)) The Act also provides that rules similar to Code Sec. 51(i)(1) (which disallows the work opportunity tax credit, or WOTC, when the employee is considered related to the employer) and Code Sec. 52 (which provides rules for apportioning the WOTC among commonly controlled businesses) apply. (Act Secs. 503(a)(3), (b)(3), and (c)(3)) Special Rule on Earned Income for EITC & CTC Purposes Current law. Under Code Sec. 32, an eligible individual is allowed an earned income tax credit (EITC) equal to the credit percentage of earned income (up to an earned income amount ) for the tax year. For 2017, the earned income amount is $6,670 for taxpayers with no qualifying children, $10,000 for those with one qualifying child, and $14,040 for those with two or more qualifying children. For purposes of the EITC, earned income includes wages, salaries, tips, and other employee compensation, but only if those amounts are includible in gross income for the tax year; plus net earnings from self-employment less the Code Sec. 164(f) deduction for half of self-employment tax for the year. (Code Sec. 32(c)(2)(A)) Under Code Sec. 24, individuals can claim a $1,000 child tax credit (CTC) for each qualifying child the taxpayer can claim as a dependent. The child must be 6

7 under 17 and a U.S. citizen or resident alien. (Code Sec. 24(c)) The amount of the allowable credit is reduced (not below zero) by $50 for each $1,000 (or fraction thereof) of modified adjusted gross income (AGI increased by excluded foreign, possession, and Puerto Rico income) above: $110,000 for joint filers, $75,000 for unmarried individuals, and $55,000 for married taxpayers filing separately. (Code Sec. 24(b)) To the extent the CTC exceeds the taxpayer's tax liability, the taxpayer is eligible for a refundable credit equal to 15% percent of earned income in excess of a threshold dollar amount. (Code Sec. 24(d)) New law. The Act provides that, in the case of a qualified individual, if the earned income of the taxpayer for the tax year which includes the applicable date (i.e., the dates shown in the following paragraph) is less than the taxpayer's earned income for the preceding tax year, then the taxpayer may, for purposes of the EITC and CTC, substitute the earned income for the preceding year for the earned income for the tax year that includes the applicable date. (Act Sec. 504(c)(1)) If the election is made, it applies for both Code Sec. 24(d) and Code Sec. 32 purposes. For Hurricane Harvey, a qualified individual is one whose principal place of abode on Aug. 23, 2017 was located either in the Hurricane Harvey disaster zone, or in the Hurricane Harvey disaster area and the individual was displaced from their principal place of abode by reason of Hurricane Harvey. Similar definitions apply for Hurricane Irma (using a Sept. 4, 2017 date) and Hurricane Maria (using a Sept. 16, 2017 date). (Act Sec. 504(c)(2)) In the case of joint filers, the above election may apply if either spouse is a qualified individual. (Act Sec. 504(c)(5) 7