Hurricane Katrina Tax Relief
A Summary of Provisions for Affected Individuals, Businesses, and Charitable Donors

By Rebecca Carr and Tina Quinn

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The act provides special rules for use of retirement funds, employment relief, charitable-giving incentives, and additional tax relief provisions. In addition to providing relief to individuals and businesses, the act includes tax breaks for relief workers. Section 501 of the act declared an emergency requirement so the need for balancing of revenues and expenditures is suspended. Advisors should familiarize themselves with the act’s provisions and make efforts to determine who can benefit from it.

Key Terms

The act defines the “Hurricane Katrina disaster area” as the area declared a major disaster area by the President before September 14, 2005. The “core disaster area” means that part of the Hurricane Katrina disaster area that warrants individual or public assistance from the federal government. The IRS has designated 31 Louisiana parishes, 47 Mississippi counties, and 10 Alabama counties as part of the core disaster area. (See www.irs.gov.) In addition, 33 Louisiana parishes, 35 Mississippi counties, 12 Alabama counties, and 11 Florida counties make up the remainder of the Hurricane Katrina disaster area.

Title I

Title I of the act provides special rules relating to the use of retirement funds for relief relating to Hurricane Katrina. Section 101 allows an eligible individual to withdraw up to $100,000 (in the aggregate) from retirement plans [e.g., IRA, 401(k)] without paying the 10% early-withdrawal penalty. In addition, these funds are not subject to the usual 20% mandatory withholding on withdrawals. Eligible individuals may pay income tax on the withdrawn amounts ratably over a three-year period. Also, if the withdrawals are recontributed to the plan within three years, the amounts will be given rollover treatment. If the taxpayer has previously filed a tax return and declared the withdrawals as income, he may file an amended return to get a refund. Eligible individuals are those whose principal place of abode on August 28, 2005, was located in the Hurricane Katrina disaster area and who suffered an economic loss from Hurricane Katrina.

Section 102 allows recontributions of qualified distributions from retirement plans for home purchases cancelled due to Katrina. These distributions must have been made after February 28, 2005, and before August 29, 2005. The recontributions will be treated as rollovers if made between August 25, 2005, and February 28, 2006. The funds from a qualified distribution must have been intended for the purchase or construction of a principal residence in the Hurricane Katrina area, and the purchase or construction could not take place because of Hurricane Katrina. Eligible individuals are those whose principal place of abode on August 28, 2005, was located in the Hurricane Katrina disaster area and who suffered an economic loss from Hurricane Katrina.

Section 103 increases the loan limit from a qualified employer plan from $50,000 to $100,000 for qualified individuals if the loan takes place after September 23, 2005, and before January 1, 2007. For the purposes of this section, a qualified individual is one whose principal place of abode on August 28, 2005, was located in the Hurricane Katrina disaster area and who suffered an economic loss from Hurricane Katrina. This section also, under certain circumstances, delays the due date for repayments due after August 24, 2005, and before December 31, 2006.

Section 104 enumerates the rules for retroactive application of amendments made by this title or by regulation to existing retirement or annuity contracts.

Title II

Section 201 extends the Work Opportunity Tax Credit to make Hurricane Katrina employees a targeted group. Unlike the traditional groups covered by the Jobs Credit, many of the employees are very employable. The credit is 40% of the first $6,000 of wages paid to the qualified employees.

For the purposes of section 201, the term “Hurricane Katrina employee” includes two groups. The first includes any individual who on August 28, 2005, had a principal place of abode in the core disaster area and who is hired during the two-year period beginning on that date for a position in the core disaster area. The second group includes individuals who lived in the core disaster area and were displaced by reason of Katrina. An individual in this group must be hired by December 31, 2005, but need not be hired for a position in the core disaster area.

Employers do not need to obtain the certificate required under subparagraph (A) of IRC section 51(d)(12) for claiming the Work Opportunity Credit for other targeted groups. The employee will provide reasonable proof that he is a Hurricane Katrina employee to the employer.

Section 202, an employee-retention credit for small employers affected by Hurricane Katrina, allows employers of less than 200 workers to receive a tax credit of 40% on up to $6,000 of continuing payments made to eligible workers during the period of their business inoperability. An eligible employer is one within the core Katrina area whose business was inoperable for at least one day. This credit applies regardless of whether the employee performs no services, performs services at a different location, or performs services at the principal place of employment prior to resumption of significant operations. An eligible employee is one whose principal place of employment on August 28, 2005, was with this employer in the core disaster area. This credit will be part of the general business credit under section 38(b) of the IRC of 1986.

Title III

Title III includes provisions to encourage charitable giving. Section 301 suspends the income percentage limits on cash charitable gifts for both individuals and corporations applicable to gifts given between August 28, 2005, and December 31, 2005. In the case of corporations, charitable gifts must be made to relief efforts pertaining to Hurricane Katrina. For individual taxpayers, the cash must simply be given to a section 170(b)(1)(A) organization other than a section 509(a)(3) organization. In addition, individual taxpayers will not be subject to the 3% of adjusted gross income (AGI) phase-out of itemized deductions under IRC section 68.

Taxpayers will have to separate on their tax returns the amount of charitable contributions made prior to August 28, 2005, and those taken on August 28, 2005, or later.

The allowance to take all of the contribution currently is an election. In the case of a partnership or an S corporation, the election is to be made by at the partner or shareholder level. Note that this is available to all taxpayers, not just those economically affected by Hurricane Katrina.

Section 302 allows an additional reduction of $500 of taxable income for taxpayers housing Katrina victims. For a taxpayer to qualify for the exemptions, a Hurricane Katrina–displaced individual must live in the taxpayer’s home rent-free for a period of at least 60 consecutive days after August 28, 2005. The taxpayer is limited to four such exemptions ($2,000 maximum). The person for whom the exemption is earned may not be the taxpayer’s spouse or a dependent of the taxpayer. The exemption will be disallowed if the taxpayer receives rent or other compensation for providing the housing, whatever the source of the compensation.

The taxpayer must include the taxpayer identification number of the Katrina victims on the tax return to be entitled to the exemption. A person is a Hurricane Katrina–displaced individual if such person lived in the Katrina disaster area and her place of abode was damaged or the person was evacuated from her home due to Katrina. This exemption will be available for tax years beginning in 2005 and 2006, but the taxpayer may use the exemption in only one of those two years.

Section 303 increases the standard mileage rate for charitable use to 70% of the standard business rate in effect at the time of the charitable use, if the use pertains to providing relief relating to Hurricane Katrina. Any increase may be rounded up to the next highest cent. The mileage rate increase begins on August 25, 2005, and ends on December 31, 2006. (For 2005 this means that at least two different rates apply. The federal mileage rate was 40.5 cents on August 25, 2005, and increased to 48.5 cents on September 1, 2005. So the rate will be 29 cents beginning on August 25, 2005, and increase to 34 cents on September 1, 2005.)

Section 304 allows charitable volunteers to exclude mileage reimbursements from gross income if such use is in connection with Hurricane Katrina relief. This does not apply to persons who receive compensation for their services. Also, “double-dipping” is not allowed: If a person receives a mileage reimbursement that is excluded from income under this section, he cannot take a deduction or credit from gross income with respect to such mileage. The mileage exclusion begins on August 25, 2005 and ends on December 31, 2006.

Section 305 allows an enhanced charitable deduction for contributions of food inventory made between August 28, 2005, and December 31, 2005. This deduction may be taken by any trade or business, as long as the food is “apparently wholesome food.” The enhanced deduction will be the lesser of the basis plus 50% of the property’s appreciated value, or two times basis. Taxpayers other than C corporations are limited to an aggregate deduction for food of 10% of the taxpayer’s aggregate net income. Section 305 defines “apparently wholesome food” as that considered such under the Bill Emerson Good Samaritan Food Donation Act. Therefore, it must be fit for human consumption and meet all quality and labeling standards of government. The food need not be donated for Hurricane Katrina use, but must meet the normal donee use under IRC section 170.

Section 306 allows an enhanced charitable deduction for contributions of book inventories to public schools. The enhanced deduction will be the lesser of the basis plus 50% of the property’s appreciated value, or two times basis. The donee must be a public school providing elementary or secondary education. The donee must certify in writing both that the books are be suitable for use in the donee’s educational program, and that the donee will use them in its program. Such contributions must have been made after August 28, 2005, and before January 1, 2006.

Title IV

Section 401 allows for exclusions from income of certain cancellations of indebtedness because of Hurricane Katrina. This exclusion is for individuals whose main place of abode was in the core disaster area or for individuals living in the Hurricane Katrina disaster area who sustained an economic loss. The exclusion does not apply to business debts or to the extent that the debt is secured by real property outside the Hurricane Katrina area. The exclusion applies to cancellations of debts on or after August 25, 2005, and before January 1, 2007.
Section 402 suspends the $100 floor and 10%-of-AGI reductions to personal casualty losses in the Hurricane Katrina area on or after August 25, 2005, if such losses are attributable to Hurricane Katrina. The reductions of casualty losses from section 165(h)(2)(A) will continue to apply to non-Katrina losses and without regard to Katrina losses.

Section 403 granted the Treasury Secretary the power to suspend the date of filing and payment of employment and excise taxes. This expands the Secretary’s previous power to suspend the due dates of income, estate, and gift taxes. For application in respect to Hurricane Katrina, it postponed such due dates until at least February 28, 2006. The suspension refers to items that were not expired prior to August 25, 2005.

Section 404 suspends certain requirements for home loans financed by mortgage revenue bonds for residences in the Hurricane Katrina disaster area that were determined to be uninhabitable. The limit on such loans was increased to $150,000. This section will not apply to any financing provided after December 31, 2007.

Section 405 extends the replacement period for nonrecognition of gain under involuntary conversion for property located in the Hurricane Katrina disaster area from two years to five years. To qualify, the property must have been “compulsorily or involuntarily” converted on or after August 25, 2005, by Hurricane Katrina, and substantially all of the use of replacement property must be in that area.

Section 406 allows Katrina disaster victims whose earned income in 2005 is less than their earned income in 2004 the choice of computing the earned income credit based on actual 2005 earned income or earned income from the preceding year. For purposes of errors made in this determination of the earned income credit, incorrect use on a return of earned income will be treated as a mathematical error.

Section 407 gives the Treasury Secretary or his delegates the authority to make adjustments in the application of laws so that temporary relocations caused by Hurricane Katrina do not cause taxpayers to lose deductions or credits that they would have otherwise been entitled to, and that such relocation does not cause a change of filing status.