IRS Responds to Natural Disasters

The IRS reacted quickly to the devastation caused in the aftermath of Hurricanes Katrina and Rita. Even as the House and Senate worked on the Hurricane Katrina Tax Relief Act of 2005 (S 1696; H 3786) and enacted the Katrina Emergency Tax Relief Act of 2005 (KETRA) (P.L. 109-73), various changes had al-ready been announced; see, e.g., IR News Releases 2005-84, 2005-91 and 2005-96. These issues include estimated taxes and corporate, individual, employment and excise tax return extensions. Additionally, benefit plans and Consolidated Omnibus Budget Reconciliation Act of 1985 continuation coverage deadlines were extended; see Notice 2005-60. Hardship withdrawals from retirement plans were addressed in Ann. 2005-70. The IRS has assured individuals, businesses and tax advisers that it is working aggressively to monitor filings and resolve other potential tax administration issues as they are identified.

Extension of Filing Deadlines

IR-2005-112 describes the additional time provided by KETRA for tax filings by Katrina victims; IR-2005-110 explains the relief for Rita victims. Taxpayers now have until Feb. 28, 2006 to file returns and pay taxes due, if the original due date was after Sept. 22, 2005. Compliance activities in affected areas are also suspended until that date. Importantly, taxpayers need to (1) identify themselves as being affected by one of these hurricanes and (2) live in one of the affected areas, to receive tax relief. The means of obtaining relief may differ for taxpayers affected by the storms, but living in other locations. The definition of affected differs for the two hurricanes.

Workers involved in the relief effort also have until Feb. 28, 2006 to file any returns and pay taxes due. Essentially, they are entitled to the same extensions that apply to individuals and businesses located in the disaster areas. Under Regs. Sec. 301.7508A-1(d)(1)(iii), relief workers affiliated with a recognized government or philanthropic organization, who are assisting in a disaster area are included in the class of affected taxpayers entitled to filing relief. They should mark on appropriate tax filings Hurricane Katrina or Hurricane Rita in red ink. The IRS will abate interest and any late filing, late payment or failure-to-deposit penalty that would otherwise apply.

Leave-Sharing Programs

Notice 2005-68 outlined leave-based donation programs. Employees will not be taxed if they forgo vacation, sick or personal leave in exchange for employer contributions of amounts to charitable organizations providing relief to Hurricane Katrina victims. The employer will make cash payments to qualified tax-exempt organizations involved in the relief effort. Employees who choose to contribute their forgone time will not have to include the donated leave in income if the payments are made before Jan. 1, 2007. There will be no constructive receipt of income to the employee. Consequently, employees cannot claim a charitable deduction for the value of forgone leave excluded from their income.

The incentive to the employer is that the deduction is not subject to the various charitable contribution limits under Sec. 170; thus, the forgone wage contribution is deductible under Sec. 162. The amounts are free of income and payroll tax withholding, because they are not included in Box 1 (wages, tips, or other compensation), Box 3 (Social Security wages, if applicable), or Box 5 (Medicare wages and tips) of Form W-2. Note: These rules apply for 2005 and 2006, so employers continue to have time to adopt leave-based donation programs.

IR-2005-86 reminds taxpayers that deductible donations must be made to qualified charities; the contribution substantiation rules apply. Charitable contributions remain available only to taxpayers who itemize. Even nonitemizers will benefit from leave-sharing programs, however.

Example: X, an employee who does not itemize, forgoes $1,000 worth of vacation time in 2006 that his employer contributes to a charity aiding Katrina victims. The $1,000 is omitted from Xs income, the same tax result as a $1,000 charitable contribution. This treatment would not be available if X took the vacation and contributed $1,000 to an eligible charity.

Enhanced tax benefits may be available for those with lower adjusted gross incomes, as numerous phaseouts are based on gross income before deductions. For example, forgoing leave may yield a higher deduction for a contribution to a traditional IRA. Employers and wage earners save Social Security taxes on the excluded income. Retirement plan participants should review how compensation is defined in the employers retirement plan, however, as forgone time may limit annual contributions.

Standard Mileage Rate Increase

In response to the concurrent
dramatic increase in gasoline prices, Ann. 2005-71 increased the mileage allowance deduction for the business use of automobiles from Sept. 1Dec. 31, 2005. Although gasoline is the major factor in the mileage figure, other items enter into the calculation of mileage rates, such as the price of vehicles and insurance. Accordingly, the 2006 rates will be set closer to January 2006, at which time gasoline prices may have stabilized.

As detailed in Ann. 2005-71, the optional standard mileage rate increased 8, to 48.5 per mile, for all business miles driven during the applicable period. The rate for medical or moving expenses is increased from 15 to 22 per mile, for the same period.

Ann. 2005-71 detailed the circumstances in which the standard mileage rate applies, as it is optional under certain circumstances. For example, if an expense deduction or accelerated depreciation method was used for the vehicle in a prior period, the mileage rate may not be used.

The rate for providing services for charitable organizations is codified in Sec. 170(i) and remains at 14 per mile.

Planning Strategies

Business owners should be advised of the increase in the mileage rate, to determine if their individual reimbursement plans should be revised. Individuals should be aware of the increase for year-end tax planning. Feasibly, a worker with an accountable plan may be reimbursed at 40.5 for the entire year and have an additional unreimbursed 8 a mile expense for the final four months of 2005. Tax advisers will need to keep in mind the pre- and post-Sept. 1, 2005 amounts.

Employers may want to review leave-based donation programs to assist workers who have expressed interest in assisting hurricane victims by contributing to the relief effort.

As the disaster relief topic is a moving target, tax advisers should keep abreast of new developments.

From Rosemary Ervin, CPA, Hunter Group, Fair Lawn, NJ