Tax Byte
Federal Disaster Relief Act Makes Big Changes to Casualty Loss Deduction: Key Provisions for Tax Practitioners
The Federal Disaster Relief Act of 2023 (enacted December 12, 2024) introduces significant modifications to disaster-related tax provisions that practitioners should consider when advising clients affected by qualified disasters. This analysis covers key provisions and implementation considerations for tax professionals.
Effective Dates and Qualification Criteria
The Act’s general provisions apply to presidentially declared disasters from January 1, 2020, through February 11, 2025 (60 days post-enactment). However, practitioners should note the special carve-out for California wildfire disasters, which extends retroactively to December 31, 2014.
Modified Casualty Loss Treatment
The Act fundamentally alters the traditional casualty loss framework for qualified disasters. Key modifications include:
- Removal of AGI Threshold: The Act eliminates the 10% adjusted gross income reduction threshold previously required for casualty losses. The Act changes the casualty loss floor from $100 to $500 per event for federally declared disasters, effective for tax years beginning after December 31, 2023.
Note: eliminating the 10% of AGI threshold will allow more taxpayers to claim disaster losses.
Example: Randy’s house was damaged in Hurricane Helene. He is insured but his deductible is $5,000. Under prior law, 10% of is AGI wiped out any deductible loss. Under the new law he is able to deduct $4,500 ($5,000 less $500 floor).
- Elimination of Itemization Requirement: Clients can now claim qualified disaster losses regardless of whether they itemize deductions. This represents a significant departure from previous requirements and expands access to relief.
Note: 90% of taxpayers take the standard deduction. This change is important to many victims of disasters.
Example. Randy’s house was damaged in Hurricane Helene. He is insured but his deductible is $5,000. Because Randy takes the standard deduction, he would not have received a benefit from his small loss under prior law. Under the new law, Randy can add his $4,500 ($5,000 less $500 floor) to his standard deduction.
Disasters Hit Throughout the US
Extreme weather events have increasingly affected communities across the United States, including wildfires in the West, devastating floods in the Northeast, powerful hurricanes in the South, and severe drought conditions in the Southwest. California wildfires are in the news, but The Federal Disaster Relief Act of 2023 will provide tax benefits to tens of thousands of taxpayers.
California Wildfire Provisions
For clients affected by California wildfires, practitioners should note these specific provisions related to federally declared wildfires from December 31, 2014 forward.
- PG&E Fire Victim Trust Payments:
- Settlement payments from the $13.5 billion PG&E Fire Victim Trust
- Covers fires including:
- 2015 Butte Fire
- 2017 North Bay Fires (including Tubbs)
- 2018 Camp Fire
- Both lump sum and periodic payments are now exempt
- Attorney fees portion of settlements also exempt
- Edison International Settlements:
- Payments related to the 2017 Thomas Fire
- 2018 Montecito Mudslides compensation
- Related litigation costs and attorney fees
- Southern California Edison Settlements:
- Woolsey Fire (2018) related payments
- Subsequent debris flow compensation
Key Changes in Tax Treatment
- Exemption Coverage:
- Principal settlement amounts
- Attorney fees and costs
- Interest portions of settlements
- Property loss compensation
- Personal injury compensation
- Business interruption payments
- Benefits Protection:
- The new tax exemption preserves eligibility for:
- Covered California premium subsidies
- VA benefits
- Federal student aid (FAFSA)
- Other means-tested programs
- The new tax exemption preserves eligibility for:
Retroactive Relief
- Taxpayers who previously reported these payments as income may file amended returns
- Retroactive relief available for payments received from December 31, 2019 forward
- Applies to amounts previously included in gross income
Federal and State Tax Treatment
The significant change from the Federal Disaster Relief Act of 2023 is that it aligns federal tax treatment with what California had already done at the state level. This creates consistency between federal and state tax treatment.
East Palestine Train Derailment Considerations
For clients affected by the February 3, 2023, East Palestine derailment, practitioners should consider these specific provisions:
- Qualified Payment Sources:
- Federal, state, or local government agencies
- Norfolk Southern Railway
- Subsidiaries, insurers, or agents of Norfolk Southern Railway
- Covered Compensation Categories:
- Property value diminution
- Real estate transaction costs, including realtor commissions
- Inconvenience compensation related to property access
Implementation Considerations
Tax practitioners should consider these practical aspects when implementing the new provisions:
- Documentation Requirements: While the Act removes certain thresholds, maintaining detailed documentation of losses remains crucial for substantiation.
- Amended Returns: Consider reviewing prior year returns for clients in qualified disaster areas, particularly California wildfire victims, to identify amendment opportunities.
Looking Forward
The Act’s provisions interact with broader disaster relief funding initiatives, including a pending $100 billion emergency aid package through March 2025. Practitioners should monitor IRS guidance on implementation details and any technical corrections legislation.
For California practitioners, note that the historic use of a discharge petition to advance this legislation (only the third successful use in the 21st century) highlights its significance and broad bipartisan support.
The Act represents a significant shift in disaster tax relief, emphasizing accessibility over traditional limitations. Practitioners should carefully review these provisions against their client base to identify relief opportunities while maintaining appropriate documentation standards.