Tax Breaks for Katrina Victims

Congress has readied more than $6 billion in temporary Katrina tax breaks for displaced families, good Samaritans and Gulf Coast businesses that hire low-income workers to get up and running again.

House and Senate negotiators say the bill will be on President Bush’s desk by week’s end. A second round of hurricane-related tax breaks is also in the works despite a new report from the nonpartisan Congressional Research Service that concludes tax breaks do little to help low-income families displaced by hurricanes and other disasters.

Key provisions of the Katrina Emergency Tax Relief Act:

  • Waive the 10 percent early-withdrawal penalty for Katrina victims who take hardship distributions of up to $100,000 from their tax-deferred 401(k)-style retirement savings plans. They still will owe income tax on the payout, but can spread the tax bill over three years. No tax will be due if the money is repaid in three years. Separately, Katrina victims can borrow up to $100,000 from these retirement plans, up from the current $50,000 limit. The Internal Revenue Service already speeded up a rules change to allow hardship withdrawals from 401(k) plans for taxpayers whose principal residence is damaged.
  • Protect taxpayers dislocated by Katrina from losing their $1,000-a-child tax credit or the Earned Income Credit for lower-income workers because of changed living circumstances. Individuals have the option of using their 2004 income to calculate both credits on 2005 returns.
  • Insure families against being taxed on forgiven debt. The bill changes current law that treats discharged indebtedness as taxable income. For instance, Katrina victims whose mortgage companies cancel their home loans won’t be taxed on the balance due.
  • Allow full deductibility of casualty losses not covered by insurance. Current law allows taxpayers who itemize to deduct casualty losses to the extent they exceed 10 percent of adjusted gross income plus another $100. The change lets Katrina victims deduct the full amount of uninsured losses so that a taxpayer with $40,000 adjusted gross income could deduct the full loss of a car valued at $5,000, not $900.
  • Give property owners who receive insurance payments more time to buy or rebuild without the money being taxable income. Current law requires the money to be invested in a replacement property within two years to avoid income tax, or four years for damage to a principal residence in a presidentially declared disaster area, but this will extend Katrina disaster area replacement investment to five years.
  • Let friends, family and strangers claim special personal exemptions if they provide rent-free housing to displaced Katrina victims for 60 days or more. Exemptions could amount to $500 a person, up to $2,000, on 2005 or 2006 tax returns. The special exemption cannot apply to spouses or dependents who already qualify for the regular personal exemption, which is $3,200 for 2005.
  • Set the standard mileage rate for using your personal vehicle for charitable work at 70 percent of the standard business mileage rate, which the IRS raised last week by 8 cents to 48.5 cents a mile to reflect Katrina’s impact on oil prices. The standard charity rate was 14 cents a mile, as set by Congress.
  • Employers who hire or keep Katrina victims on payrolls can qualify for the Work Opportunity Tax Credit worth up to $2,400 an employee. Employers in New Orleans and other hard-hit areas may claim the credit for employees the next two years, while employers elsewhere who hire displaced Katrina workers qualify for the credit the rest of 2005.

Forget calls by congressional Democrats and others to safeguard Katrina victims against the tough new bankruptcy law that kicks in Oct. 17: Republicans in charge of committees that oversee the bankruptcy code say the new statute already lets debtors claim “special circumstances” that make it impossible to repay creditors.

Sen. Charles Grassley, R-Iowa, and Rep. James Sensenbrenner, R-Wis., cite a provision that gives bankruptcy judges latitude to decide if people qualify to shed their debts and get a fresh start by filing Chapter 7 bankruptcy.

Otherwise, the new law requires people who make more than their state median income the previous six months to file Chapter 13 and repay some or all of their debts. It also subjects them to a “means test” that puts them on a court-supervised budget.

Michigan Rep. John Conyers, the ranking Democrat on the House Judiciary Committee, introduced legislation waiving these provisions for Katrina victims, but Sensenbrenner doesn’t even plan a hearing on the proposal.

(Contact Mary Deibel at DeibelM(at)