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ABA Seeks Prompt Guidance on Claiming COVID-19 Disaster Losses

Posted on Sep. 15, 2020

IRS guidance addressing myriad issues affecting taxpayers’ ability to claim 2020 coronavirus pandemic disaster losses on their prior year’s return requires prompt release as taxpayers finalize their 2019 returns, one group says. 

In a September 14 comment letter, the American Bar Association Section of Taxation makes specific recommendations for clarifying how section 165(i) disaster loss rules should apply in a novel disaster such as the coronavirus pandemic, “unlike previous federally declared disasters, in that it is not the result of a force of nature,” such as a hurricane, fire, or flood. 

“Because taxpayers are in the midst of finalizing 2019 return filings, we ask that guidance addressing ambiguities under section 165(i) be published as quickly as possible so that taxpayers may take confirmed positions on originally filed returns rather than with amended return filings,” the group said. 

Without definitive guidance, “the resolution of these issues will occur on a case-by-case basis through examinations, which will be disadvantageous for both taxpayers and the government,” the ABA tax section warns. 

Practitioners have raised numerous questions about how the provision that has most often been applied to property casualty losses would apply to the pandemic, suggesting that it’s an area in need of IRS guidance. 

President Trump’s declaration of the coronavirus crisis as a federal disaster that warrants government assistance under the Stafford Act triggered an additional tax planning tool — beyond the provisions in the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) — that permits acceleration of specified disaster losses.

Section 165(a) allows a deduction for any loss sustained during the tax year and not compensated for by insurance or otherwise. Allowable loss deductions are generally claimed in the year of the loss.

However, losses attributable to a federally declared disaster may be deducted on the taxpayer’s prior-year return under section 165(i) — allowing taxpayers that suffered a loss and in need of cash the opportunity to monetize those losses more quickly and reinvest in the business by reducing prior-year taxes.

Under reg. section 1.165-11, taxpayers must elect to deduct a disaster loss in the preceding year either on an original or an amended income tax return within six months of the initial due date for filing the return for the year in which the disaster occurred.

Thus, the relief provided under section 165(i) provides “possible cash flow benefits in that a taxpayer may reduce tax payments for 2019 and request a ‘quickie refund’ of overpaid estimated taxes,” the ABA tax section said. It also noted that the disaster loss deduction taken into account in 2019 could result in net operating losses that may be carried back to a profitable tax year.

Attributing Losses

A disaster loss is defined as one that occurs in a federally declared disaster area, is attributable to that disaster, and is otherwise allowable as a deduction under section 165(a) and reg. section 1.165-1 through 1.165-10

The ABA tax section points out that the phrase “attributable to” is not defined in the context of section 165(i) or reg. section 1.165-11, and thus it recommends that Treasury and the IRS issue guidance that defines the term as “due to, caused by, or generated by,” consistent with existing case law. 

An outstanding issue has been the treatment of stock that has become worthless because of the pandemic and the declared disaster, for which the ABA tax section recommends guidance that clarifies that “taxpayers may elect to apply section 165(i) to losses arising from worthless stock that otherwise are deductible under section 165(g) and are attributable to the COVID-19 pandemic.” 

The letter specifically recommends that “worthless stock deductions arising from check-the-box liquidations of insolvent members of a consolidated group also should be eligible for section 165(i)” disaster loss deductions. 

Taxpayers should be allowed to “elect to apply 165(i) on a transaction-by-transaction basis or, alternatively, to apply the provision separately to each trade or business,” according to the tax section. 

Physical Damage Not Required

Reg. section 1.165-11, promulgated in the 1960s, originally provided that the section 165(i) election for disaster loss rules applied to losses arising from fire, storm, shipwreck, or other casualty. Treasury later clarified in amended regulations that the election “is properly available whenever a taxpayer incurs a deductible disaster loss whether or not that loss is technically a ‘casualty’ loss.” 

The amount deductible for casualty losses under reg. section 1.165-7 is generally the lesser of the decline in the fair market value or the adjusted basis of the property determined under section 1011, adjusted for salvage value and insurance or other compensation received. 

The scope of “other casualty” is unclear, according to the tax section, which cited Rev. Rul. 72-592, 1972-2 C.B. 101, for the IRS’s requirements for a loss to qualify as such, including “‘complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, and unusual nature.’” 

The tax section recommends that the IRS issue guidance “expressly declaring that the COVID-19 pandemic is an ‘other casualty’ for purposes of Treas. Reg. section 1.165-7, that losses arising from the COVID-19 pandemic satisfy the requirement of a sudden event, and that physical damage to property is not a prerequisite to claiming a casualty loss deduction.” 

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