Tuesday, February 3, 2015



This article is part of a series of articles emphasizing several ways taxpayers can be trapped by problems in dealing with the tax reporting obligations resulting from a major casualty loss event.

There are two phrases that practitioners need to be aware of that are often taken for granted and not examined in the documentation stage of claiming a casualty loss deduction:
The rules specify that a loss to be deductible must be settled. To be settled the event must “have occurred” and be “settled.” “Settlement” is often clear, the insurance claim has been closed, the taxpayer is satisfied… the loss is “settled.”
But there are cases where the claim is still open at the time the tax return is filed (or, even that the claim is still open as of the end of the reporting tax year). How does this affect the reporting of the loss? The question that must be resolved is whether there is a “reasonable prospect of recovery as of the point a decision must be made in order to file a tax return?”
This is an important question, often overlooked, that will be covered in this article. To start, we need to understand the status of the taxpayers’ situation.
Here is a common situation:
1.      Insurance coverage is not adequate to compensate for the loss or in some cases no insurance coverage is adequate.
2.      The taxpayer seeks relief through deduction of the loss as a casualty (net of insurance proceeds received) to help fill the gap in insurance coverage.
Aggressive tax deductions, in some cases, can turn around and cause significant tax cost to the taxpayer. What is the determining factor to guide the taxpayers’ decision to deduct any loss?
The key factor is a determination of the prospect of recovery.
1.  One taxpayer wants to deduct a loss and must hold off claiming loss if there is a reasonable prospect of recovery.
Another taxpayer:
2.  This taxpayer wants to delay deduction and has questionable basis for delay.
A 1953 tax case is useful to determining how to proceed: Callan 54-1 USTC ¶9109.
The legal tax concept that must be resolved is whether there is a “Reasonable Prospect of Recovery.”
We have to start with the actual IRS regulation as excerpted below:
Summary of §1.165-1(d)(1) and (2):
(d) Year of deduction
(1)   A loss shall be allowed asfor the taxable yearloss is sustained. [A] loss shall be treated as sustained during the taxable year in which the loss occurs as evidenced by closed and completed transactions and as fixed by identifiable events occurring in such taxable year.
(i)   If …, in the year of such casualty or event, there exists a claim for reimbursementthere is a reasonable prospect of recovery, no portion of the lossis sustained, …, until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. [A] reasonable prospect of recovery existsis a question of fact to be determined upon an examination of all facts and circumstances. Whether or not such reimbursement will be received …, by a settlement of the claim, by an adjudication, or by an abandonment of the claim. [B]y abandonment, … must be able to produce objective evidence of his having abandoned the claim
(ii)   Ifportionis not covered by a claim for reimbursementsuch portion of the loss is sustained during the taxable year in which the casualtyoccurs.

From the Callan case, here are some thoughts of the Court on the subject that are worth considering:
Application of concept of Reasonable Prospect to a fact situation should be: One of reasonableness
Evidenced by closed and completed transactions
Fixed by identifiable events
Substance and not mere form will govern
Actual and present loss, not contemplated as more or less sure to occur
The standard for determining year for deducting a loss is a flexible, practical one, varying according to the circumstances of each case
Taxpayer’s attitude and conduct are not to be ignored
Whether and when a deductible loss results ... is a factual question ... to be decided according to surrounding circumstances
Whether there was any other identifiable later event which might reasonably be looked to in fixing the date of loss
Loss may become complete enough for deduction without taxpayer’s establishing there is no possibility of eventual recoupment . . .
Mere existence of unsatisfied claim is not enough to prevent loss from being held deductible
Inflexible rule not needed
Taxpayer not required to be incorrigible optimist or incorrigible pessimist
Only fair test is foresight, not hindsight
Sustained in year cannot fairly be made by confining the trier of facts to examination of taxpayer’s beliefs and actions
To codify them as the decisive is to surround the clear language of code and regs. with an atmosphere of unreality and impose grave obstacles to efficient administration
According to surrounding circumstances … encompass myriad criteria for gauging the reasonableness of the taxpayer’s action or inaction, such as whether there was an actual physical loss resulting in a definite, fixed amount of damage.

Now that you have fully understood the meaning of all the thoughts of the Court, maybe, like me, you are hot heartened by the Court’s analysis.

JOHN TRAPANI assists both taxpayers directly and advises taxpayers’ tax professionals.
This material was contributed by John Trapani. A Certified Public Accountant who has assisted taxpayers since 1976, in analyzing and reporting transactions of the type covered in this material.  

© 2015, John Trapani, CPA,
All rights to reproduce or quote any part of the chapter in any other publication are reserved by the author.


Certified Public Accountant

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(805) 497-4411       E-mail John@TrapaniCPA.com

Blog: www.AccountantForDisasteRrecovery.com

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Tax Advice Disclaimer
Any implication of accounting, business or tax advice contained in this material is not intended as a thorough, in-depth analysis related to your specific issues. It is not a substitute for a formal opinion including a discussion or your specific situation. It is not sufficient to avoid tax-related penalties. If desired, John Trapani, CPA would be pleased to perform the requisite research, specific to your facts and circumstances and provide you with a detailed written analysis. Such an engagement would be the subject of a separate engagement letter letter that would define the scope and limits of the desired consultation services.
This material was completed on the date of the posting

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