Katrina Tax Relief Act in Plain English

Dear Friends,
The “Katrina Emergency Tax Relief Act of 2005” is aimed at helping residents in the hurricane-ravaged areas of Louisiana, Mississippi and Alabama rebuild their homes and lives as quickly as possible. Here’s a rundown of the major provisions:

No Change in Tax Filing Status Due to Relocation:

Hurricane victims who have been forced to live with friends, relatives, or in other kinds of temporary housing will not lose various tax benefits due to the change in their living situation. To avoid this, they will be allowed to use their 2004 income to calculate their eligibility for such things as the child tax credit and the Earned Income Tax Credit for 2005.

If you filed as “Head of Household” in 2004, you can do so for 2005 even if you are now living in someone else’s home because yours was damaged by the storm.

Tax Break for Those Providing Temporary Housing

Anyone providing rent-free housing to Hurricane Katrina victims for at least 60 days will be able to take a tax deduction of $500 per person. The maximum deduction is $2,000.

No Tax on Debt Relief

Under the regular tax rules, if a creditor forgives your debt, this is considered income and the amount is subject to tax. Under this Act, if a debt — such as your mortgage — is cancelled as a result of the hurricane you will not have to pay income tax on this.

Losses are Fully Deductible

Normally, casualty losses are only deductible to the extent they exceed 10 percent of your adjusted gross income (AGI). In addition, the first $100 of this amount is disallowed. For instance, if your AGI were $80,000 and Katrina caused $50,000 in damages to your home, you’d only be able to deduct $41,900 ($50,000 – 8,000 - 100). However, Katrina victims will be allowed to deduct 100 percent of their hurricane-related losses.

Deadline for Using Insurance Proceeds Extended

In order to avoid tax on insurance payments, the money must be used to replace damaged or lost property. Businesses have two years to reinvest the money; individuals have four. In both cases, the deadline is extended to five years provided the replacement property “is located within the disaster area.”

Expanded Low-Interest Mortgages

While states and local government entities can issue bonds to raise money for mortgages to lower-income homebuyers, this Act removes the requirement that the individual be a “first-time” home purchaser. It also permits loans of up to $150,000 for the purpose of repairing <existing> homes in the declared disaster area.

Penalty-Free Retirement Plan Withdrawals

Katrina victims who withdraw money from their company retirement plans or IRAs in order to make repairs or pay bills will not be hit with the usual 10 percent early withdrawal penalty even if they are under age 59 1/2. The maximum withdrawal is $100,000. In addition, these individuals can spread the income tax on these withdrawals over three years instead of having to pay the entire amount in the year of the distribution.

If your company retirement plan offers “hardship” loans, the maximum amount is temporarily increased from $50,000 to $100,000.

Tax Deadlines Extended

Individuals who were supposed to submit income, estate, or gift taxes will now have until Feb. 28, 2006 to do so. This includes filing tax returns and making estimated payments.

Incentives for Charitable Contributions

People who donate cash to a bona fide charity supporting Hurricane Katrina relief efforts will be able to deduct the entire amount. Normally, the amount you can deduct is limited to 50 percent of your AGI. This is further reduced because itemized deductions are phased out at higher income levels.

This measure also waives the 10 percent income limitation on corporate donations to charity.

As a result of this Act, individuals or corporations that make charitable contributions in cash will be able to deduct 100 percent of the amount, provided the donation is made before Jan. 1, 2006.

Tax Break for Using Your Personal Vehicle

Volunteers who use their own car or truck in their charitable work can deduct 14 cents per mile — much less than the 48.5 cents per mile that the I.R.S. just approved for business use.

Through the end of this year, this Act raises the mileage deduction for Katrina aid workers to 34.2 cents per mile. It further states that if a volunteer is reimbursed for his mileage by the charity, he will not have to pay income tax on this amount.

Donations of Food or Books

Subject to certain limitations, C-corporations that donate food to charity can deduct the value. Under this measure, other types of business entities, such as S-corporations, partnerships and sole proprietors, can receive the same tax break.

An entity that donates educational materials to schools in the hurricane-affected area will be able to deduct this contribution.

In both cases, the food or books must be donated by the end of this year in order to qualify for this special tax break.

Tax Incentives for Employers

There are a number of tax breaks for companies that employ Katrina victims. For instance, the “Work Opportunity Tax Credit” (WOTC), which gives employers a tax credit for hiring individuals in certain target groups, has been expanded. It now includes anyone who lived in the area that is eligible for assistance under something called the “Stafford Act.”

Employers <within> the assistance area can claim the credit for the next two years. Companies outside the area are also eligible for the credit if they hire WOTC individuals from the declared disaster area before the end of this year.

Small Business Tax Credit

Companies in the Katrina disaster area with 200 or fewer employees are eligible for a tax credit of up to $2,400 for each employee they keep on the payroll. This is available even if the employee is working at another facility.

Long-Term Relief Package to Come

As it did for New York City following the 9/11 Terrorist Attacks, Congress is expected to pass additional, longer-lasting tax breaks to help New Orleans and the rest of the declared Katrina disaster area recover.

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