Close Close
Sign In
Newsletters
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards
Podcast Center Video Center Webcasts Resource Center Events
About ThinkAdvisor Contact Us Advertise With Us Asset & Logo Licensing Sitemap Terms of Service Privacy Policy Copyright © 2024 ALM Global, LLC. All Rights Reserved.
ThinkAdvisor
A resident walks back home on a flooded street following Hurricane Ian in Fort Myers, Florida, US, on Thursday, Sept. 29, 2022. Hurricane Ian, one of the strongest hurricanes to hit the US, weakened to a tropical storm but continues to dump rain on the state as it makes its way up the US Southeast. Photographer: Eva Marie Uzcategui/Bloomberg

Retirement Planning > Saving for Retirement

How to Get Tax Breaks, Tap Retirement Accounts After a Natural Disaster

By John Manganaro

X
Your article was successfully shared with the contacts you provided.

It is an unfortunate truth that millions of Americans find themselves grappling with the aftermath of natural disasters in any given year, and the past few years in particular seem to have delivered more than their fair share of adversity.

From deadly fires in Hawaii to catastrophic flooding in Vermont, 2023 has brought significant hardship to many American communities. While the lives lost are obviously the deeper tragedy, the temendous collective financial burden adds to the challenges of rebuilding and recovery.

According to data from the National Oceanic and Atmospheric Administration, at a national level, the total cost of major natural disasters between 2018 and 2022 topped $595 billion, with a 5-year annual cost average of $119 billion. This latter figure is nearly triple the long-term inflation-adjusted annual average cost for Americans, NOAA notes.

One silver lining to be found in the wake of such tragedies is the willingness of the federal government, via the Internal Revenue Service, to deliver additional financial flexibility to those grappling with their aftereffects, which can range from damaged or destroyed homes to lost working time and weakened local economies.

Among the government’s most important tools is the permission of penalty-free hardship withdrawals from tax-advantaged retirement accounts, including 401(k) plans and IRAs. The IRS will also often extend key filing deadlines related to these accounts and taxpayers’ other reporting and monetary obligations.

While rightly seen as a key lifeline for Americans in disaster areas, this flexibility comes with a number of key nuances and requirements that can easily cause taxpayers to make mistakes, some of which can be costly. As such, it is important for individuals (and their financial professionals) to study up on the IRS’ disaster relief playbook.

Doing so can help ensure Americans can quickly and efficiently access their savings and investments during times of extraordinary need, without running afoul of the nation’s complex and ever-changing tax rules.

See the list below for a rundown of key facts all Americans should know about retirement savings, hardship declarations, disaster relief and income taxes, drawn from IRS resources and the ALM’s Tax Facts library.

Want more tax-focused insights? Find current and accurate answers to your tax questions with Tax Facts.

Presidentially Declared Disasters

As recounted on the IRS website, the Bipartisan Budget Act of 2018 mandated changes to the 401(k) hardship distribution rules, and in November of that year, the IRS released proposed regulations to implement these changes.

The IRS released final regulations about a year later, and generally, these changes relaxed certain restrictions on taking a hardship distribution, including in disaster situations.

Under the framework established in 2019, in the event of a presidentially declared disaster, the IRS will postpone certain retirement plan and IRA deadlines for affected taxpayers. For example, the IRS may extend the 60-day period for plan participants to deposit eligible rollover distributions to another qualified plan or IRA, or it may extend the time for a qualified retirement plan to make a required minimum distribution.

Most presidentially declared disasters are severe storms such as tornadoes and hurricanes, but they may also be wildfires, flooding or earthquakes. Affected taxpayers are generally people who live in or have a business in an area directly affected by the disaster.

Soon after a disaster is declared, the IRS will issue a news release describing the type of relief; which deadlines are being postponed; the taxpayers eligible for relief; and duration of the relief period, among other key information.

Secure 2.0 and Natural Disasters

With passage of the Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act in 2022, the rules governing access to retirement accounts in the wake of natural disasters were changed again, this time being relaxed to allow penalty-free access to retirement funds in certain common circumstances.

If the disaster qualifies as a federally declared disaster, taxpayers can now generally access up to $22,000 per disaster without application of the 10% early withdrawal penalty.

Further, the tax liability generated by the retirement account withdrawal can be spread over three years, and taxpayers can typically repay the funds within three years of the withdrawal to avoid tax consequences altogether.

The maximum loan amount for individuals experiencing a qualified disaster was also increased to $100,000.

The expanded rules apply to any federally declared disaster occurring on or after Jan. 26, 2021.

Generally, to be eligible for a qualified disaster recovery distribution, or QDRD, a participant’s “principal place of abode” must have been in the disaster area during the incident period, and the participant must have sustained an economic loss because of the disaster.

This framework was taken from the earlier Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020, which allowed individuals to withdraw up to $100,000 from a retirement plan such as their 401(k) or an IRA without a penalty if they are under age 59.5. Those rules have since expired.

Casualty Loss Deduction Changes

Importantly, the general rules for deducting expenses associated with casualty and disaster losses outside of federally declared disasters were overhauled as part of the Tax Cuts and Jobs Act of 2017.

As such, clients must understand both the complexities that have always existed in claiming the casualty loss deduction and those associated with changes made by the current tax law framework.

Prior to 2017, most victims of natural disasters were entitled to take a federal tax deduction for losses that were not reimbursed by insurance. However, under the TCJA framework, individual taxpayers are no longer entitled to a general deduction for casualty loss expenses — assuming that those losses were not related to property used in a trade or business.

Despite this, the current law contains an exception for certain federal casualty losses, meaning those that occur in federally declared disaster areas.

Additionally, if a taxpayer has personal casualty gains, the new rules do not apply (even if the loss does not occur in a federal disaster area) so long as the losses do not exceed the gains. This essentially means that casualty losses can be used to offset casualty gains even after the 2017 overhaul.

Because of these new rules, if a taxpayer sustains losses in a natural disaster, the client should first be advised to check the FEMA website to determine whether the federal government has declared a federal disaster in the area where their property was located.

Even if the disaster does occur in a federally declared disaster area, the client will still be required to itemize deductions on Schedule A in order to claim the deduction — meaning that total itemized deductions must exceed the standard deduction threshold of $27,700 per married couple or $13,850 per individual in 2023.

How to Claim a Casualty Loss Tax Deduction

To itemize such a casualty loss deduction, the client will need to include the FEMA disaster declaration number on Form 4684 and attach that form to their federal income tax return for the year.

Section A of the form deals with personal casualty losses, while Section B is where the client reports any business casualty losses.

Determining the value of the casualty loss deduction begins with determining whether the property was income-producing (business-related) property or personal property. The value of the casualty loss deduction for business property is generally the adjusted basis of the property (i.e., the price paid plus the value of any substantial long-term improvements, minus depreciation claimed), assuming that the property was completely destroyed.

For personal use property, the deduction is valued at how much the property’s fair market value decreased because of the damage caused by the disaster or the client’s basis in the property (whichever value is lower). The same formula applies to business-related property that was not entirely destroyed.

The calculation does not end there, however. The client must then account for any actual or anticipated insurance reimbursement or salvage value of the property. After that reduction, the client subtracts 10% of their adjusted gross income from the value to reach the actual dollar figure that can be deducted.

Pictured: A street flooded by Hurricane Ian in Fort Myers, Florida, in 2022. Photo: Eva Marie Uzcategui/Bloomberg

John Manganaro

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.