In a rare bit of good news for those whose lives were turned upside down by Hurricane Katrina, Congress has approved more than $6 billion in temporary Katrina tax breaks for displaced families in order to get them up and running again. People who donated money and volunteered their time for relief efforts will also get bigger tax write-offs this year as well.
But any taxpayer remotely involved with the hurricane should take a look at the new tax laws during the holidays — a few deadlines must be met before year’s end or soon after.
“We know folks who are still in the disaster areas or who have fled from them may not be thinking about their taxes right now, but it really could be a quick way to get some extra cash,” said Internal Revenue Service spokesperson Nancy Mathis.
Many states affected by Hurricanes Katrina and Rita are still working on what tax guidelines they’ll offer to affected residents for tax year 2005, but the final results won’t be known until after the holidays. Regarding tax-filing extensions, deadlines for those receiving second extensions on 2004 tax returns and those filing quarterly returns in October will be extended to February 28, 2006 for Hurricane Rita and Katrina victims, but no word yet on whether 2005 tax returns can be submitted after next year’s deadline of April 16.
For the time being, the new tax provisions in place are for people affected only by Katrina.
Key provisions of the Katrina Emergency Tax Relief Act:
Residents who suffered property damage get full deductibility of casualty losses not covered by insurance. The current law allows taxpayers who itemize to deduct casualty losses to the extent they exceed 10 percent of adjusted gross income (AGI), plus another $100.
“Normally, if you have a casualty loss, you would have to deduct $100 from your loss and that amount is then reduced by 10 percent of your AGI to get the amount that you can deduct, “ said Sara Turner, tax researcher for the National Association of Tax Professionals. "So if you claim a loss of $10,000 on your car and your AGI is $50,000, the loss would be reduced by 10 percent of your AGI, or $5,000, plus another $100, so you would have $4,900 to deduct. The new act throws that out the window and you would get the full loss of $10,000.”
The IRS will also waive the 10 percent early-withdrawal penalty for Katrina victims whose principal residence was damaged to take hardship distributions from their tax-deferred 401(k)-style retirement savings plans. Also, they can now borrow up to $100,000 from these retirement plans, up from the current $50,000 limit. They still will owe income tax on the payout, but can spread the tax bill over three years. No tax will be due if the money is repaid in three years.
Retirement-plan withdrawals for home purchases
For those who took money from their tax-deferred retirement plans before August 29 in order to buy or build a house in an area damaged by Katrina and then decided against doing so, they can put their money back in the plan and not be taxed the 10 percent penalty if they do so before February 28. The IRS will treat the replacement as a rollover.
Current tax credits
The new tax laws protect taxpayers dislocated by Katrina from losing their $1,000-a-child tax credit or the Earned Income Credit for lower-income workers because of changed living circumstances. They may use either their 2004 income level or their 2005 income, whichever helps them most.
The bill insures families against being taxed on forgiven debt since it changes the current law that treats discharged indebtedness as taxable income. For instance, Katrina victims whose mortgage companies cancel their home loans won't be taxed on the balance due.
Property owners who receive insurance payments get more time to buy or rebuild without the money being taxable income. Current law requires the money to be invested in a replacement property within two years to avoid income tax, or four years for damage to a principal residence in a federally-declared disaster area, but this act will extend Katrina disaster area replacement investment to five years.
Also, money given to victims in the form of aid from charities or the government is not considered taxable income.
Tax preparation and filing help
Obviously, the new changes will make filing federal tax returns more complex. Reconstructing as many records as possible will be essential to helping you claim all the tax credits and deductions to which you are entitled, so you may need additional help.
“Since many people usually make mistakes when they file every year, it’s probably a good idea to get a qualified tax preparer this time around to help you and make sure you’re getting all the deductions you’re eligible for,” said Turner.
The IRS recommends that you write "Hurricane Katrina" atop your tax return in red ink. It has also set up a toll-free telephone number just for people affected by Katrina (1-866-562-5227). Low-income taxpayers ($35,000 or less) can also call or visit a local IRS office for assistance to seek assistance if they have casualty losses. Currently, the IRS is working with professional organizations like the American Institute of Certified Public Accountants and the National Association of Enrolled Agents to organize volunteer CPAs who will assist Katrina victims free of charge, but official details won’t be released until early 2006.
Bigger deductions for donors
Since many Americans gave generously to hurricane victims, the IRS is allowing more of their donations to qualify as tax deductions. The Katrina act allows consumers to deduct up to 100 percent of their cash donations from their adjusted gross income, up from 50 percent in previous years. Even better, it's not even limited to hurricane-related charities since the limit is removed for any gift regardless of the receiving organization’s designated cause (although they must be nonprofit and nonpolitical).
The catch: The law covers donations only made between August. 28 and December 31. So to take advantage, act now.
If your donation is less than $250, all you need to show the IRS is proof of payment. For donations above $250, keep more detailed records, such as the letter the group sent you acknowledging your donation.
Also, raffles don’t fully count. If you donate money or goods but in return receive a gift or other benefit, you can deduct only that portion of your donation that exceeds the value of any benefit you received.
Special tax breaks for Katrina helpers
The new act looks especially fondly on those who went above and beyond the call of duty.
If you opened your home to house hurricane victims, you can claim up to $2,000. The amount is limited to $500 per person, and the evacuees must have stayed in your home for at least 60 days and not in another property you own.
Another special tax break is available if you volunteered transportation services for relief efforts. Normally, you can deduct your volunteer mileage at a rate of 14 cents a mile, but the new tax law lets you deduct 70 percent of the 40.5-cent business mileage allowance for the miles you traveled for Katrina efforts. You should obtain a written record from a registered charity confirming your volunteer work and whether you received any reimbursements for your expenses. Turner also suggests you keep documentation of the dates and the number of miles you drove.