This report discusses the Katrina Emergency Tax Relief Act which was signed into law by President Bush on September 23, 2005. It primarily contains temporary tax relief intended to directly and indirectly assist individuals in recovering from Hurricane Katrina. The provisions cover a variety of areas, including work credits, charitable giving, and casualty losses

Lunder, Erika

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1 Section 501 is the act’s sole provision that does not deal with tax relief.  It designates any partof the act that has an effect on receipts, budget authority, or outlays to be an emergencyrequirement pursuant to section 402 of H.Con.Res. 95.2 IRC § 72(t).Order Code RS22269Updated October 24, 2005Katrina Emergency Tax Relief Act of 2005Erika LunderLegislative AttorneyAmerican Law DivisionSummaryOn September 23, 2005, President Bush signed the Katrina Emergency Tax ReliefAct of 2005 (KETRA; H.R. 3768) into law, P.L. 109-73.  It primarily containstemporary tax relief intended to directly and indirectly assist individuals in recoveringfrom Hurricane Katrina.  The provisions cover a variety of areas, including work credits,charitable giving, and casualty losses.  This report summarizes the act.The Katrina Emergency Tax Relief Act of 2005, P.L. 109-73, provides tax relief thatis intended to assist the victims of Hurricane Katrina.1  Some of its provisions distinguishbetween the “Hurricane Katrina disaster area,” which is the presidentially declareddisaster area, and the “core disaster area,” which is the portion of the disaster areadetermined by President Bush to warrant individual or individual and public assistanceunder the Stafford Act.Title I — Use of Retirement Funds for Hurricane Katrina ReliefSection 101 waives the 10% penalty tax that would otherwise apply on an earlywithdrawal from a retirement plan2 if the individual’s principal place of abode on August28, 2005, was in the Hurricane Katrina disaster area and the individual sustained aneconomic loss due to the Hurricane.  The section applies to distributions made betweenAugust 24, 2005, and January 1, 2007, and the maximum amount that be withdrawnwithout penalty is $100,000.  The funds may be re-contributed to a qualified plan over athree-year period and receive tax-free rollover treatment.  Additionally, with respect to thetaxable portion of the distribution, the individual may include one third of such amountin his or her income for three years rather than the entire amount in the year ofdistribution.CRS-23 IRC § 72(p).Section 102 allows individuals to re-contribute, without tax consequences,distributions that were made between February 28, 2005, and August 29, 2005, topurchase or construct a principal residence in the Hurricane Katrina disaster area and werenot used because of the Hurricane.  The contributions must be made between August 24,2005, and March 1, 2006.Section 103 increases the amount that Hurricane Katrina victims may  borrow fromtheir retirement plans without immediate tax consequences.3  The provision applies toindividuals whose principal place of abode on August 28, 2005, was in the HurricaneKatrina disaster area and who sustained an economic loss due to the Hurricane.  Undercurrent law, the maximum amount that may be borrowed without being treated as ataxable distribution is the lesser of (a) $50,000, reduced by certain outstanding loans or(b) the greater of $10,000 or 50% of the present value of the employee’s nonforfeitableaccrued benefits.  For loans made between September 23, 2005, and January 1, 2007, theact increases this to the lesser of (1) $100,000, reduced by certain outstanding loans, or(2) the greater of $10,000 or 100% of the present value of the employee’s nonforfeitableaccrued benefits.  The section also extends repayment due dates by one year if the originaldate fell between August 24, 2005, and January 1, 2007.  Section 104 contains transition rules for plans adopting these new provisions.Title II — Employment ReliefWork opportunity tax credit.  Under IRC § 51, businesses that hire individualsfrom groups with high unemployment rates or special employment needs, such as high-risk youths and veterans, may claim the work opportunity tax credit.  The credit may beclaimed for the wages of up to $6,000 that were paid during the employee’s first year.  Foran employee who worked at least 400 hours, the credit equals 40% of his or her wages —thus, the maximum credit is $2400.  For an employee who worked between 120 and 400hours, the credit equals 25% of his or her wages.  The credit does not apply to wages paidafter December 31, 2005.Section 201 allows the work opportunity credit to be claimed for wages of HurricaneKatrina employees.  Eligible employees are individuals who had a principal place ofabode in the core disaster area on August 28, 2005, and either (1) are hired during the 2-year period beginning on that date for a position in the area or (2) were displaced by theHurricane and are hired between August 27, 2005, and January 1, 2006. Retention credit.  For employers with an active business that was renderedinoperable due to damage from Hurricane Katrina for any day between August 28, 2005,and January 1, 2006, section 202 provides a new credit for continuing to pay theiremployees’ wages.  The credit is equal to 40% of the wages, limited to $6,000, of eachemployee whose principal place of employment with the employer on August 28, 2005,was in the core disaster area.  It applies to wages paid between the date the businessbecame inoperable at the employee’s principal place of employment and the date itresumed significant operations there, but no later than December 31, 2005.  It may not beCRS-34 IRC § 170(i).5 IRC § 170(e).claimed by an employer with more than 200 employees or one who claims a workopportunity credit for the wages.Title III — Charitable Giving IncentivesLimits on charitable deductions.  Under IRC § 170, individuals may not claima charitable deduction that exceeds 50% of their “contribution base” (adjusted grossincome with certain adjustments) and corporations may not claim a deduction thatexceeds 10% of their taxable income with certain adjustments.  Any excess contributionsmay be carried forward for five years.  Section 301 suspends the 50% and 10% limitationsfor cash contributions made between August 27, 2005, and January 1, 2006.  Forindividuals, the deduction may not exceed the amount that the taxpayer’s contributionbase exceeds his or her other charitable contributions.  For corporations, the deduction isallowed only for contributions used for Hurricane Katrina relief efforts and  may notexceed the amount that the corporation’s taxable income exceeds its other contributions.The act also suspends the overall limitation on itemized deductions for individuals.Housing exemption.  Section 302 of the bill allows individuals who provide freehousing for at least 60 consecutive days to persons displaced by Hurricane Katrina toclaim personal exemptions for those persons.  The exemption is $500 per person, with amaximum of four exemptions per year.  They  are available in 2005 and 2006, althougha taxpayer may claim a person only once.  The taxpayer must include on his or her returnthe displaced person’s taxpayer identification number.  In order to qualify, the displacedperson must have had a principal place of abode on August 28, 2005, in the HurricaneKatrina disaster area.  If the home was not in the core disaster area, then either the homehad to have been damaged by the Hurricane or the person was evacuated due to it.Mileage rate for charitable contribution deduction.  Individuals who usetheir personal vehicles for charitable purposes may claim a deduction based on thenumber of miles driven.  The statutory amount is 14 cents per mile.4  Section 303 sets therate at 70% of the standard business mileage rate (rounded to the next highest cent) if thevehicle is used for Hurricane Katrina relief between August 24, 2005, and January 1,2007.  The standard business mileage rate is periodically set by the IRS and is currently48.5 cents per mile.Mileage reimbursement. Section 304 excludes from a charitable volunteer’sgross income any qualifying mileage reimbursements received from the charitableorganization for the operating expenses of the volunteer’s passenger automobile.  Theexpenses must arise from using the vehicle for Hurricane Katrina relief between August24, 2005, and January 1, 2007.Inventory.  In general, donors of food inventory who are not C corporations mayonly claim a charitable deduction that equals their basis in the inventory (typically, itscost).5  C corporations may deduct the lesser of (1) the basis plus 50% of the property’sappreciated value or (2) two times basis.  Section 305 allows all donors of wholesomeCRS-46 IRC § 61(a)(12).7 IRC §§ 102 and 108.  8 IRC § 108(a).9 The heading of section 401(c)(2) refers to “[r]eal property outside core disaster are,” while thesection’s language refers to real property located outside of the Hurricane Katrina disaster area.10 IRC § 165.food inventory to benefit from this enhanced deduction if the donation is made betweenAugust 28, 2005, and January 1, 2006.  Donors who are not C corporations may notcompute the deduction using contributions in excess of 10% of their net business income.Section 306 allows C corporations to claim an enhanced deduction for donations ofbook inventory to public schools if made between August 27, 2005, and January 1, 2006.The corporation may deduct the lesser of (1) the basis plus 50% of the property’sappreciated value or (2) two times basis.  The school must certify that the books aresuitable and will be used in its educational program.Title IV — Additional Tax Relief ProvisionsDischarge of indebtedness.  When all or part of a debt is forgiven, the amountof the cancellation is ordinarily included in the income of the taxpayer receiving thebenefit of the discharge.6  There are currently several exceptions to the general rule thata cancelled debt is included in taxable income in the year of discharge. For example, noamount of the discharge is included in income if the cancellation is intended to be a giftor is from the discharge of student loans for the performance of qualifying services.7There are also certain situations in which the taxpayer may defer taxation, with thepossibility of permanent exclusion, on income from the discharge of indebtedness, suchas if discharge occurs when the debtor is in title 11 bankruptcy proceedings or insolvent.8Section 401 allows victims of Hurricane Katrina to exclude non-business debt thatwas forgiven by a governmental agency or certain financial institutions if the dischargeoccurred between August 24, 2005, and January 1, 2007.  Individuals are eligible for thisbenefit if their principal place of abode on August 25, 2005, was in the core disaster areaor if it was in the Hurricane Katrina disaster area and they suffered an economic loss dueto the Hurricane.  The exclusion does not apply if the real property that secured the debtwas located outside of the Hurricane Katrina disaster area.9  Individuals with certain taxattributes (such as basis) would be required to reduce them by the amount excluded fromincome, which has the effect of deferring the tax on the cancelled debt.Casualty losses.  There are several circumstances under which taxpayers maydeduct losses of property not connected to a trade or business, including when the lossesare from a casualty, such as a hurricane.10  In addition to losses from the actual damagecaused by the casualty, a taxpayer in a presidentially declared disaster area has a casualtyloss if ordered, within 120 days of the area’s designation, by the state to demolish orrelocate his or her home because it is unsafe due to the disaster.  The amount of the lossis the lesser of (1) the decrease in the property’s fair market value due to the casualty or(2) the taxpayer’s adjusted basis in the property (i.e., the cost of the property with certainCRS-511 26 CFR § 1.65-7(a)(2)(ii).12 The actual authority to postpone the deadlines is granted to the Secretary of the Treasury.  Forinformation on IRS administrative actions after Hurricane Katrina, see CRS Report RS22261,Hurricane Katrina: The Response by the Internal Revenue Service, by Erika Lunder.13 IRC §§ 7508(a)(1)(A) and (B).14 IRC § 143.15 IRC § 1033.adjustments).  The cost of repairing the property may be used as evidence of the amountof loss.11  There is no loss if the taxpayer is reimbursed by insurance or other means.  Thetaxpayer may only claim a deduction to the extent that the loss from the casualty exceeds(1) $100 plus (2) the sum of 10% of the taxpayer’s adjusted gross income and any taxablegains from property that was involuntarily converted due to a casualty (discussed above).In general, the deduction may only be claimed in the year of the loss, although a loss ina presidentially declared disaster zone may be deducted in the year prior to the loss.Section 402 waives the $100 and 10% floors for casualty losses from HurricaneKatrina.IRS Authority to suspend tax-related deadlines.  Under IRC §§ 7508 and7508A, the IRS has the authority to postpone tax-related deadlines for certain taxpayers,including those affected by a presidentially declared disaster.12  These deadlines includethose for filing returns and making payments for income, gift, and estate taxes.  Incometaxes withheld at source and employment taxes are explicitly excluded, and excise taxesare not mentioned.13  Section 403 gives the IRS the authority to postpone deadlines relatedto employment and excise taxes.  Additionally, while the IRS announced in News ReleaseIR-2005-96 that it would extend deadlines for Hurricane Katrina victims until January 3,2006, section 403 further extends the deadlines to February 28, 2006.Mortgage revenue bonds.  Mortgage revenue bonds are tax-exempt bonds usedto finance below-market  rate mortgages for low and moderate-income homebuyers whohave not owned a home for the past three years.14  Homes in targeted areas, which areareas that are low-income or of chronic economic distress, are subject to special rules that,among other things, remove the requirement that the homebuyer not have owned a homefor the past three years.  Section 404 similarly removes the three-year requirement if thehome is in the core disaster area or if it is a replacement residence for an individual whoseoriginal residence in the Hurricane Katrina disaster area was made uninhabitable by theHurricane. The provision applies to financing provided before January 1, 2007. Thesection also increases the limitation on qualified home improvement loans from $15,000to $150,000 for loans used to repair damage from the Hurricane.Involuntary conversions.  An involuntary conversion occurs when property isconverted to money or other property because of its complete or partial destruction, theft,seizure or condemnation, or if it is disposed of under threat of condemnation.15  Anexample of an involuntary conversion is when an individual receives an insurancepayment for damaged property.  If the cash or property that was received is worth lessthan the basis of the property that was converted, the taxpayer has a loss, which mayqualify for deduction under the casualty loss rules discussed below.  If the cash orCRS-616 The taxpayer’s basis in the new property is the same as in the converted property; thus, he orshe is able to defer recognition of any gain until he or she sells or exchanges the new property.17 When a taxpayer’s principal residence or its contents are involuntarily converted due to apresidentially-declared disaster, he or she does not recognize any gain upon receiving insuranceproceeds covering unscheduled personal property located in the residence.  The other insuranceproceeds, including amounts received for the residence and scheduled items, are combined intoa common pool of funds.  The taxpayer has four years to use any of the pooled funds to purchasereplacement property for the residence or its content in order to take advantage of the non-recognition rules.  IRC § 1033(h). property received is worth more than the basis of the property that was converted, thenthe taxpayer has a gain, which may or may not be immediately taxable.  There are no immediate tax consequences if the property is converted to property thatis similar or related in service or use (“similar property”).16  If, on the other hand, theproperty is involuntarily converted to cash or dissimilar property, the taxpayer mustrecognize any gain unless he or she purchases similar property within a certain timeperiod.  If the taxpayer purchases the replacement property in a timely manner, then heor she may elect to only recognize gain to the extent that the amount realized from theinvoluntary conversion exceeds the cost of the new property.  The time period is generallytwo years.  It is increased to three years if the converted property is business real propertyand to four years if the property is the taxpayer’s principal residence or its contents whichwere involuntarily converted due to a presidentially-declared disaster.17  Additionally, theIRS has the discretion to extend the time period on a case-by-case basis.  Section 405 increases the time period to purchase the replacement property to fiveyears.  The extended period applies for property in the Hurricane Katrina disaster area thatwas converted due to the Hurricane so long as substantially all of the use of thereplacement property occurs in the disaster area.Credit computations.  Section 406 allows Hurricane Katrina victims to elect touse last year’s earned income for computing the child tax credit [IRC § 24] and the earnedincome tax credit [IRC § 32] instead of this year’s income.  It applies to individualswhose principal place of abode on August 25, 2005, was in the core disaster area or wasin the Hurricane Katrina disaster area and who were displaced by the Hurricane.Authority to make adjustments relating to status.  Section 407 allows theTreasury Secretary to make adjustments in the application of the tax laws for tax years2005 and 2006 so that temporary relocations due to Hurricane Katrina or the receipt ofrelief does not cause taxpayers to lose dependency exemptions or child credits or to havea change of filing status.

Katrina Emergency Tax Relief Act of 2005

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Katrina Emergency Tax Relief Act of 2005

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