Thursday, November 19, 2009



Ask many accountants how many federally declared disasters there have been in California from the beginning of 2008 to today, you will get a wide range of answers. Of course they remember the literally thousands of fires – yes thousands, plural, that California had in the Spring of 2008, the fires last fall and then again in the spring and summer of 2009. So many catastrophes to pick from. And yet only one federal disaster was declared in the 22 month period. The one disaster was a combination of three fires that were physically unconnected to each other, but raged at the same time in mid-November of 2008. The Tea Fire in Santa Barbara, the Sayre Fire in Sylmar area of Los Angeles and the Freeway Complex Fire in the Yorba Linda area that touched Los Angeles, Orange and Riverside Counties were combined into one federal disaster.

The later fire in Santa Barbara known as the Jesusita Fire that destroyed 80 homes and the Station Fire that burned 160,000 acres (an area larger than the whole of the Isle of Manhattan in New York) that burned over 80 homes were not declared federal disasters. The Governor did not even attempt to request a later declaration from the federal government.

It is worth noting the following facts:

Under the protocol of the Robert T. Stafford Disaster Relief Act that was enacted into federal law in 2007, there are three levels of FEMA assistance, but there is only one level of assistance that qualifies for the implementation of tax benefits to flow to citizens. The other two levels only provide assistance to state and local governments’ cost of dealing with the situation. Generally, in the case of all these assistance levels, the Federal government picks up 75% of the state and local governments’ expenses related to the event.

Only a Title IV event under the Robert T. Stafford Disaster Relief Act triggers tax benefits to citizens.

The Jesusita Fire that destroyed over four times the area than the earlier Tea Fire destroyed “only” about 1/3 the number of home that the Tea Fire destroyed (230 for the Tea Fire).

The State of California and local fire agencies did receive 75% funding of their firefighting costs for the Jesusita Fire and the Station Fire.

The two non-disaster levels of assistance are “Fire Management Assistance” and “Emergency Management Assistance.”

Going back to October 22, 2007, FEMA picked up the cost of fighting 27 fires in California, see list below. Only three of these were subsequently upgraded to federal disasters, as noted above.

Fire Management Assistance Declarations
Year Date Incident Disaster Number
2009 10/04 Sheep Fire 2841
2009 09/22 Guiberson Fire 2839
2009 09/01 Pendleton Fire 2836
2009 08/31 Oak Glen Fire 2833
2009 08/31 49er Fire 2832
2009 08/28 Station Fire 2830
2009 08/28 PV Fire 2828
2009 08/15 Yuba Fire 2825
2009 08/13 Lockheed Fire 2824
2009 05/06 Jesusita Fire 2817
2008 11/15 Freeway Complex Fire 2792
2008 11/15 Sayre Fire 2791
2008 11/14 Tea Fire 2790
2008 10/13 Sesnon Fire 2789
2008 10/12 Mareck Fire 2788
2008 09/02 Gladding Fire 2786
2008 07/08 Camp Fire 2782
2008 07/04 Basin Fire Complex 2781
2008 07/04 Gap Fire 2780
2008 06/22 Wild Fire 2776
2008 06/20 Trabing Fire 2775
2008 06/11 Martin Fire 2772
2008 06/11 Humboldt Fire 2771
2008 06/10 Ophir Fire 2770
2008 05/22 Summit Fire 2766
2008 04/27 Santa Anita Fire 2763
2007 10/22 Rice Fire 2739

FEMA also made one “Emergency Declaration” on June 28, 2008. An excerpt from that notice of the Declaration appears below:
“WASHINGTON, D.C. -- … (FEMA) announced that the President declared an emergency exists in the state of California and ordered federal aid to supplement state and local response efforts in the area struck by wildfires beginning on June 20, 2008 and continuing.
“FEMA Administrator David Paulison said that the President's action authorizes FEMA to coordinate all disaster relief efforts which have the purpose of alleviating the hardship and suffering caused by the emergency on the local population, and to provide appropriate assistance for required emergency measures, authorized under Title V of the Stafford Act, to save lives and to protect property and public health and safety, and to lessen or avert the threat of a catastrophe in Butte, Mendocino, Monterey, Santa Clara, Santa Cruz, Shasta, and Trinity counties.
“Specifically, FEMA is authorized to identify, mobilize, and provide at its discretion, equipment and resources necessary to alleviate the impacts of the emergency. Emergency protective measures, limited to direct Federal assistance, will be provided at 75 percent Federal funding.”

The Tea Fire, Sayre Fire and Freeway Complex Fire were initially Fire Management Assistance Declarations that later turned into one Disaster Area. While these three fires were physically unconnected, they were combined into one disaster declaration request that was made by the governor.

As noted in a prior entry, the Tea Fire burn area actually stopped the progress of the Jesusita Fire on one front. “Neighbors” who lost their homes in the Jesusita Fire do not get the same tax benefits that those who lost their home in the Tea Fire are able to enjoy. This is true, even though there may be people in each group who are neighbors.

Is it right that state and local governments get assistance, but that citizens do not? Send me an email with your thoughts.

Tuesday, July 7, 2009



When a catastrophe hits it is a personal disaster whether or not the federal government declares it a “Federal Disaster Area.” The process for an area being declared a “Federal Disaster Area” is usually handled by political entities. The timing is very critical and the people who are directly involved are dealing with personal matters, including the health and safety of their families. These people are not thinking about “Federal Disaster Declarations.”

But, when the politicians do not respond, or are given “logical” reasons why the event is not a “Federal Disaster” the people must step up and fight for the Declaration.

The Process:
The Robert T. Stafford Disaster Relief Act sets out the process and parameters for the federal government’s declaration of the “Federal Disaster Area.” People who experience a Federal Disaster are able to benefit from financial and tax benefits provided by various agencies of the federal government.

The Income Tax benefits are different for those who realize a gain and those who realize a loss; they include the following:

Gain or Loss

How can I have a gain, I just lost my home?

The basic tax computation depends on four numbers to determine whether a gain or loss has been realized.

Those amounts are:
1. Insurance proceeds – Structures and Personal Property,
2. Cost basis of home, including building, land improvements, land and building improvements and modifications since acquisition,&
3. Decrease in value as a result of the catastrophic event, defined as the difference between the
(a) Fair market value of the property immediately before the event and
(b). Fair market value immediately after the event,

If the insurance proceeds (1) exceed the cost basis (2), there is a gain that has been realized regardless of the economic loss which is based on the Scope of Loss and Appraisals.

If the insurance proceeds (1) are less than the cost basis (2) and the loss (3) is greater than the insurance proceeds (1), there may be a loss. If the loss (3), reduced by the insurance proceeds (1) is greater than the cost basis (2) reduced by the insurance proceeds (1), then there is a casualty loss.

In the case of a casualty loss, the computed loss is reduced by $100 or $500 per incident and all casualty losses for the year are further reduced by 10% of Adjusted Gross Income for the year of deduction. Adjusted Gross Income is the amount on the bottom of page one of Form 1040, the annual personal income tax return.

Now that we have the basics, let’s look at the difference between a loss or gain that is part of a federal disaster and one that is not. This discussion only deals with the differences.

For federal disasters taxpayers may claim the loss on the tax return for the year of the loss or the return for the year immediately preceding the year of the loss. This would allow a taxpayer in an event such as the Jesusuta Fire to deduct the loss on the 2009 income tax return or on the 2008 return. If the 2008 return has already been filed, an amended return may be filed. Based on the time of year of the Jesusuta Fire, the amended return must be filed no later than April 15, 2010. (No extensions are permitted.)

For disasters occurring in 2007, 2008, and 2009 additional rules apply if the loss claimed causes the taxable income to be less than zero, creating what is called a “net operating loss.” Additionally, for disasters only and in these years only, the 10% of AGI reduction does not apply.


In the case of gain, the tax on the gain can be deferred. To accomplish this, the taxpayer must reinvest the total insurance proceeds received for the loss in what is referred to as “Qualified Replacement Property” (QRP). QRP is property that has the same use and function as the property lost (In this case: any personal use real estate). In other words, if the taxpayer rebuilds the home or purchases other personal use real estate, there will be no current taxes due. (For any gains, whether or not in a disaster area, the $250,000 / $500,000 (Section 121) gain exclusion may apply.) The replacement period has two important beginning dates. The first is the date of the event. The second is the date on which the cumulative insurance proceeds received exceed the cost basis of the property lost. The replacement period is the period starting with the date of the event and extending for a period of years starting with the end of the first year in which the insurance proceeds exceed the cost basis. For disasters the number of years is four years after the end of the first year in which a gain is first realized. For none disasters it is only two years.

The second benefit in the case of a disaster is that the insurance proceeds received for personal property do not have to be reported and no computation, for tax purposes need be determined. This does not preclude a claim for a loss, if the insurance proceeds are less than the cost basis of the personal property lost. Personal property is the most difficult aspect of a casualty loss in the case of a catastrophe such as a fire that consumes the whole home and everything in it.

Additionally, in the case of a disaster, the insurance proceeds received for the personal use primary home structure may be reinvested not only in replacement real property and improvements, but also in contents. This is often a benefit if the replacement home is not completely reconstructed by the end of the replacement period, but personal property has been acquired. Additionally, if the taxpayer wishes to rebuild less, this may also be a useful advantage.

None of the benefits discussed above (except the Section 121 exclusion) are available to a group of people who have experienced a catastrophic event that has not been declared a “Federal Disaster Area.”

My suggestion when the politicians fail you:Use the internet. The FEMA site “” lists disasters by year and by state. Review each disaster for the last several years, by area involved, number of home lost, type of loss, economic impact of loss relative to size of community and any other metrics that you can think of. I am confident that there is a disaster that is less significant than many that have been overlooked as a “Federal Disaster Area.”

Once you have come up with one or two, or many, Contact your representatives.

Politicians like to give speeches, but they need to act for their constituents.

Senator Feinstein is quoted in a 2001 IRS memo (ITA 200114046). The ITA covered special circumstances related to the Cerro Grande Fire in New Mexico. The Senator’s comments relate to the importance of the Senate’s passage of legislation in 1993 that provided significant tax relief for homeowners who lose their home in a federal disaster.

Section 1033(h) was added to the Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66, just prior to the bill’s finalization by the Conference Committee. This provision was first introduced in 1992, as part of H.R. 11, which was vetoed by the President on other grounds. It was also introduced in 1993 as S. 364. The provision contained in these earlier bills was incorporated into Pub. L. No. 103-66 with virtually no changes. In describing the earlier Senate version of the provision, Senator Feinstein stated:
[T]his legislation would exclude capital gains on any unscheduled personal property. Insurance proceeds rarely if ever reimburse a taxpayer fully for their loss and this would minimize the record keeping involved in listing losses of all personal property and the replacement cost of normal household property....
139 Cong. Rec. 15 (February 16, 1993). Senator Feinstein’s remarks suggest that Congress was concerned with allowing taxpayers to replace “normal household property” with a minimum of record keeping and without having to report capital gains when they are usually not reimbursed fully for their losses.
Many individuals have “normal household property” which they do not routinely keep in their homes. For example, some individuals may store their golf clubs or baby strollers in the trunks of their cars. Additionally, some individuals may keep radios or exercise equipment at their offices. If a homeowner’s or renter’s policy covers such items when they are not physically located in the principal residence, and they are destroyed in a Presidentially declared disaster, then a taxpayer should not be denied the gain exclusion of §1033(h)(1)(A) simply because an item was in the trunk of a car or on the desk at work instead of in the basement or attic of his or her principal residence.

As to The Robert T. Stafford Disaster Relief Act, I suggest that you become familiar with Title IV, V and VI. The document is available on the Web in PDF format at: (Coy attached)

Friday, June 26, 2009



Apparently, the answer is yes. A client received a letter from the IRS recently and forwarded it on to this office. The IRS claimed that several calculations were made incorrectly on the tax return and requested that the taxpayer pay a modest amount of additional tax.

Some taxpayers who receive such a letter might conclude that the IRS was correct, the amount was small and therefore not worth bothering calling the office of the CPA who prepared the return.

This client did not do that. The letter was sent to us and I called the IRS number on the letter. At the first level, the screener decided that this was a matter that needed to be forwarded to another specialist. The specialist was very courteous and asked for specific information from the letter and tax return which was supplied. Almost immediately, the specialist indicated that the IRS was having trouble with their computer. They had not been able to fix the problem, but it was apparent that their letter was bogus. The specialist went off-line for about 15 minutes and then returned to inform me that the original calculations in the return were correct and the IRS had made a mistake. The client will be sent a letter in 2-3 weeks correcting the IRS error.

Unfortunately, the IRS only responds to inquiries. They are not determining whose returns were affected by this problem.

In any case where you receive a letter changing your tax liability, please do not hesitate to send it to me for validation. There is no charge for this review.

Saturday, June 6, 2009



Last November 230 families lost their homes in the Tea Fire in Santa Barbara County. This past May neighbors in the Tea Fire area in Santa Barbara County saw 80 families lose their homes in the Jesusita Fire.

Within two weeks of the Tea Fire, the Federal Government had declared the Tea Fire a federal disaster area. It has been a month since the Jesusita Fire started and yet the only FEMA declaration is that it is eligible for fire management assistance. It has not been declared a federal disaster area.

A federal disaster declaration opens up a number of federal assistance programs to the people who experienced the event. From an income tax perspective this includes the following:
* Ability to claim a casualty loss on either the 2008 or 2009 income tax return.
* Elimination for 2007-2009 disasters, the usual 10% of Adjusted Gross Income reduction in the amount claimed as a casualty loss.
* The normal replace period where a gain has been realized due to insurance proceeds exceeding the cost basis of the home is extended two additional years.
* Insurance proceeds for personal property do not have to be accounted for; there is no requirement that these funds be reinvested or that any computation of potential gain be computed.
* In a disaster, the proceeds received from; insurance for structure may be reinvested in a “pool” of personal use assets that may include personal use real estate and contents of the personal use real estate.
* In non-disaster situations personal property losses must be computed, a horrendous, time-consuming task. If there is a gain the proceeds must be reinvested in property that is similar or related in service or use to the property lost.

Generally, the process in disaster situations is much less restrictive and more in tune with the situation facing a large group of people who have experienced the same horrific event.

On Thursday, June 4th the offices of the two Congressional representatives were contacted. Brian Miller at Congressman Elton Gallegly’s Thousand Oaks office stated that it is the responsibility of the State of California to request the declaration and the Congressman’s office had not been aware of any request for their office personal to get involved. He also stated that it was their understanding that none of their constituents had lost a home. Additionally, when I first introduced myself at the office and asked about the Jesusita Fire, I got what amounts to be a blank response, “What Fire?”

Later, Thursday morning, my office called the Santa Barbara office of Congresswoman Lois Caps and they informed us that they were “working on it;” at least they were involved.

Then, I called a number for the California Office of Emergency Services and got voice mail. I left a message asking for information about the declaration request from their end. Finally, I sent emails to the Santa Barbara Media Center that is coordinating media and local government communication and one to the Mission Canyon Association.

It will be a very unfortunate situation if the people who experienced the Jesusita Fire are treated differently than those who experienced the Tea Fire, simply because “only” 80 homes were lost instead of 230 homes.

One of the basic reasons for declaring a catastrophe a federal disaster area is because of the impact on the community of the large number of homes that now have special needs. In this case the people who experienced the Tea Fire are still in need of assistance and they are being affected by the new Jesusita fire. They have access to services including tax relief. But the people who experienced the Jesusita Fire, who also need special assistance are also affected by the people who experience the Tea Fire are still placing strains on the resources. Yet the Jesusita Fire is being treated as a small event, not worthy of special federal assistance. Something is not working in the system.

Thursday, April 2, 2009

How Do You Document a Disaster Loss?

How Do You Document a Disaster Loss?

Substantiation of a loss is critical at the time of the loss. Building the documentation for the cost basis, any deductible loss or establishing the limits of the gain on an involuntary conversion is an important

According to the National Taxpayer Advocate's Fiscal Year 1999 Annual Report to Congress one of the most litigated Issues for individuals and small businesses carried from the 1998 Annual Report to Congress involved THEFT/CASUALTY LOSSES (Internal Revenue Code Section 165) -- Primarily issues involving the facts of a specific loss and the taxpayer's ability to establish entitlement to a deductible loss.

Avoid the disagreements, you don’t want to be in tax court, document, document, document. In many cases this is information that will be lost if not recorded properly at the time of the event.

Wednesday, March 25, 2009

What is the Tax Treatment for Ponzi / Madoff Schemes?

 What is the Tax Treatment for Ponzi  / Madoff Schemes?

After being strongly urged by Congress to issue guidance to taxpayers who have been harmed by the recent rash of Ponzi schemes, including the Bernard Madoff scam for $50,000,000,000 – that is $50 billion and maybe even more, the IRS responded with guidand in March.

The IRS issued two documents, a Revenue Ruling delineating the generic facts and IRS conclusions as to how taxpayers could file returns for relief. Their conclusions modify past rulings and relax requirements that they believe are within their authority to change. It is unlikely that anyone will challenge the “safe Harbor” method, since it is an easing of many rules.

The basic standard that they proscribe is based on the concept that the Ponzi scheme is a theft. As such it is not a capital loss or a non-business bad debt. The next issue that they establish is whether, for individual taxpayers, the kind of theft it is. If your personal car is stolen that is covered as a personal loss, subject to several adjustments that reduce the amount of the deduction. The IRS has recognized that individuals who have given funds to a Ponzi theft, did so on the basis of entering into a transaction for profit, an “investment.” As such, the loss is not subject to personal loss limitations and is fully deductible, limited only to possible recoveries.

Under this method, prior year returns will stand as filed. Under no circumstances is the IRS allowing “closed” years to be opened for “correction.” Since most of the 2008 schemes were discovered before the end of the year, it is unlikely that taxpayers will receive any 1099’s for 2008 false income.

The first question is “what is the year of the loss?” Generally, theft losses are deductible in the year of discovery and once claims for recovery have been resolved or abandoned.

The amount of the loss equals the funds invested, less any funds withdrawn, plus any amounts shown as increases to the account balance as a result of income that was supposedly earned. “Earnings” might include interest, dividends and capital gains. The fact that prior year dividends and capital gains may have “benefited” from being taxed at lower rates does not change the current year theft deduction methodology.

Because there may be claims for recovery, the IRS has established parameters for making assumptions about the recovery so that the loss can be claimed on a current (2008) tax return. To deal with the possible recovery, reductions in the loss of 5% or 25%, (depending on whom the investment was made through) and a reduction for proceeds that might be paid by SIPC (Securities Investor protection Corporation) are required.

In the second ruling, a Revenue Procedure, the IRS establishes the mechanics of dealing with the tax reporting of the loss on a 2008 tax return. The previously described concepts are converted into a schedule. If taxpayers follow the recommended method, it will be considered a “safe harbor” reducing the exposure for audit that taxpayers will potentially be subjected to.

In the future, when the dust settles and all claims are finalized there will, no doubt, be differences between what is assumed to be recoverable and what is actually recovered. If the taxpayer receives “exactly” what was assumed would be paid as embodied in the above formula, no additional tax reporting is necessary. If the taxpayer receives less, then there is an additional loss that would be reported in the year of final settlement. If there is additional proceeds that effectively reduce the loss reported, then that would be reported as income in the year received.

Net operating losses arise where certain non-personal losses exceed current taxable income. In these situations the excess that is not used in the year of the loss is a net operating loss that is subject to carry over rules. The IRS, in this case determined that “the portion of an individual's net operating loss arising from casualty or theft may be carried back 3 years and forward 20 years.” In other words, a 2008 NOL can be carried back to 2005, then 2006, then 2007, with anything remaining carried forward for 20 years. Alternatively, taxpayers can forego the carry back and only carry forward the loss. But there is additional relief available.

NOL’s arising from certain casualty and theft losses, including these are treated as a business deductions for losss an individual sustains after December 31, 2007 and therefore , is considered a loss from a "sole proprietorship". “Accordingly, an individual may elect eiither a 3, 4, or 5-year net operating loss carryback for an applicable 2008 net operating loss, provided the gross receipts test provided is satisfied.” Generally, there are small business benefits that are restricted to businesses with "$5 million" or less of annual revenue. In the case of certain casualties and thefts, including these, increases to "$15 million." All individuals that meet this test are considered “sole proprietors.”

For those interested in the technical stuff, the IRS ruling sets out the following “holdings:”

(1) A loss from criminal fraud or embezzlement in a transaction entered into for profit is a theft loss, not a capital loss, under §165.
(2) A theft loss in a transaction entered into for profit is deductible under §165(c)(2), not §165(c)(3), as an itemized deduction that is not subject to the personal loss limits in §165(h), or the limits on itemized deductions in §§67 and 68.
(3) A theft loss in a transaction entered into for profit is deductible in the year the loss is discovered, provided that the loss is not covered by a claim for reimbursement or recovery with respect to which there is a reasonable prospect of recovery.
(4) The amount of a theft loss in a transaction entered into for profit is generally the amount invested in the arrangement, less amounts withdrawn, if any, reduced by reimbursements or recoveries, and reduced by claims as to which there is a reasonable prospect of recovery. Where an amount is reported to the investor as income prior to discovery of the arrangement and the investor includes that amount in gross income and reinvests this amount in the arrangement, the amount of the theft loss is increased by the purportedly reinvested amount.
(5) A theft loss in a transaction entered into for profit may create or increase a net operating loss under §172 that can be carried back up to 3 years and forward up to 20 years. An eligible small business may elect either a 3, 4, or 5-year net operating loss carryback for an applicable 2008 net operating loss.
(6) A theft loss in a transaction entered into for profit does not qualify for the computation of tax provided by §1341.
(7) A theft loss in a transaction entered into for profit does not qualify for the application of §§1311-1314 to adjust tax liability in years that are otherwise barred by the period of limitations on filing a claim for refund under §6511.

Monday, January 26, 2009



People who experienced a Federal Disaster during the year have an important deadline to remember. By April 15 of next yar the Tax Code provides an option for those who experience a disaster and determine that they have incurred a loss as a result of the disaster.

The law allows people who have experienced a physical catastrophic event during the year that has been declared a Federal Disaster Area and who have a deductible loss may take the loss deduction on the tax return for the year of the loss or they may actually claim the loss in the tax year preceding the year it actual occurred (as if the loss actually occurred in the preceding year).

For current year disasters to deduct the loss on the prior year’s return, that return must be filed no later than April 15 of the year following the year of the loss.

For 2011 losses that are declared Federal Disasters, that means that the loss can be claimed on either the 2011 tax return that would be filed in the normal manner or it can be claim on a tax return for 2010. For losses that occur near the end of the year that does not give taxpayers a lot of time to make that decision and evaluate the information and make rational tax decisions. There are no extensions for this decision.

For losses incurred in 2011, hopefully the insurance proceeds will be sufficient to get the insured people back to their pre-event status without having to claim any losses on a tax return. Often there is no insurance or the insurance is not adequate to cover the loss. The insurance settlement process affects the ability to claim a loss. There may not be a tax loss that can be claimed. The facts must be assembled and analyzed in time to make and implement a decision before April 15 of the following year. The tax advice and analysis process should be started immediately. This could result in accelerating tax financial assistance.

In any case, the decision should be under the control of the taxpayer and not simply the result of the passage of time that closes doors of opportunity.