Introduction
We are all aware of the situation in the Gulf of Mexico. BP’s “Deepwater Horizon” oil rig exploded and sank in late April, leaving on open well behind that has been a big challenge for everybody to handle. As a result of the environmental situation, many people living and conducting business on the Gulf Coast have lost their jobs and incomes. In response, the federal government and BP have embarked on measures to reimburse the victims and businesses. And of course, like any other time when there has been money exchanged, the IRS has shown up with its guidance.
Lost Wages
There are many people who have been put out of work over the Gulf oil spill. As such, many people are taking payments from BP to recover lost wages. The guidance issued by the IRS reminds the taxpayer that such wages are still taxable despite the disaster, just as the income would have been taxed had the spill not happened at all.
Lost Business Income
Fishermen, tourist resorts, hotels, retailers and other businesses on the Gulf Coast are taking a beating trying to endure the loss of tourism, fishing, and the loss of business. BP and the federal government are making payments for lost business income as well. Any payments made to the business must be reported as business income and reported on the applicable form per the entity requirements. Money received for lost income is still ordinary taxable income.
Payments for Lost or Damaged Property
Along with lost wages and profits, certain property damage has occurred. According to IRS guidance, any money received for damaged or lost property is subject to the tax rules that were in play previous to the oil spill. Specifically, money received for depreciable business property is not taxable to the extent of the adjusted basis in the property (meaning purchase value minus depreciation taken). Any money received beyond the adjusted basis is subject to tax as if the asset were sold.
If the taxpayer loses property to an “involuntary conversion” (meaning – destroyed, stolen, condemned or disposed of under the threat of condemnation) and the taxpayer receives money for the items replacement, the taxpayer can purchase another asset and delay the tax requirements until the new asset is sold. Remember, however, this only applies if the money received is used to purchase a replacement asset. Any excess money received is fully taxable.
Casualty Losses
The rules on casualty losses remain the same as well. If a person receives money for property that has been lost or damaged as a result of the spill, taxpayers can claim casualty losses to the extent of loss suffered. The loss is determined by taking the adjusted value of the asset and subtracting any payments made by BP or other insurer for the event. For instance, if an asset with an adjusted basis of $1,000,000 is damaged and a reimbursement of $600,000 is settled upon, the taxpayer could potentially claim a casualty loss of $400,000, subject of course to the various other tax rules affecting the loss. Generally, fair market value must be determined by a qualified appraiser in order to substantiate such claim, if a challenge arises in the value and loss and something other than adjusted book value is used for the loss claimed.
Conclusion
While the payments from BP and the federal and state governments are payments that the victims deserve for their losses, the fact is that a lot of the payments made are still taxable as they would be had the spill not happened at all. It is advisable that when you or anyone you know is receiving payments from BP, a government or even if your payments are not related to the disaster, but are similar in nature, one must remember to pay the applicable taxes as required. Please call the professionals at The Center for all of your tax planning and business appraisal needs at (618) 997-3436.
By: Dr. Bart Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors