Most legal settlements are taxable, even for damages caused by a catastrophic fire. This grim fact can come as an unpleasant surprise to fire victims, and seems especially unfair. There are pending federal and California tax bills that, if passed, could make some fire lawsuit recoveries non-taxable. It’s not clear how one of these bills will fare, but there are a large number of tax bills introduced that never pass. The figures alone are not good in this respect. proposed federal bill Introduced by Congressmen Doug LaMalfa (R – Calif.) and Mike Thompson (D – Calif.) and would exempt thousands of fire victims who are receiving compensation from the PG&E Fire Victims Trust, they would have to pay federal income tax on their settlements. Payment will be exempted. There is also a California bill, AB 1249, written by Assemblyman James Gallagher, which would add a similar exemption from California state taxes. But until both provisions are passed into law, fire victims should consider their fire recovery when doing their taxes.
This does not mean paying tax on every dollar. In some cases, no recovery will actually be subject to current taxes. But it can be quite simple to turn the gross settlement figure into a viable tax reporting strategy that is defensible to the IRS and (for California, to the Franchise Tax Board). Fire victims should pay an account, including attorney’s fees. Most fire victim litigants use contingency fee attorneys. Incidental legal fees may be paid separately to plaintiff attorneys, but it is still attributed to the plaintiff for tax purposes. this is how Legal fees are treated under the tax law,
By 2018, it was clear that legal fees were almost always tax deductible. Under the Tax Cuts and Jobs Act passed in late 2017, however, many legal fees are no longer deductible. The miscellaneous itemized deduction, which accounted for most of the legal fees, was repealed for the 2018 to 2025 tax years. Accordingly, in some cases, litigants may not be able to deduct fees even if 40 per cent or more of their recovery is paid to their lawyers. Of course, attorneys must pay taxes on fees as well, so some argue that this is a form of double taxation. In any event, the tax treatment of legal fees has become a major tax problem associated with many types of lawsuits, but there are 12 ways to deduct legal fees under the new tax laws,
Fortunately, for fire victims, there is a good way to deduct or offset legal fees, for both federal and California income tax purposes. If the fire recovery can be treated as a capital gain—which it usually can—the legal fee can be treated as an additional basis in the home or as a sales expense. This could reduce the new tax law’s behavior of legal fees. In fact, it may mean paying tax only on net realizations. Of course, this still leaves a lot of tax issues to be addressed. How fire victims are taxed depends on their circumstances, what they ultimately collect, and what they claim on their taxes. Both the IRS and the California Franchise Tax Board require annual tax return filing, but a full range of tax years can be associated with fire items, including insurance recovery.
Let’s say you lose a $1 million home, but collect $1 million from your insurance carrier or PG&E. This may happen sound As if there’s nothing to tax, because you lost a $1 million home, and just got $1 million back. However, you should be aware of your tax base in the property. This usually means the purchase price, plus the cost of subsequent improvements. If it was commercial property, you need to take depreciation (and depreciation recapture) into account.
But even with personal use property like a home, your Aadhaar matters. The property may be worth $1 million upon destruction, but if the original purchase price and improvements were only $100,000, there is a profit of $900,000. Does this mean that our fire victim will have to pay tax on the $900,000 profit? Not necessarily. Fortunately, subject to requirements and limitations, tax law may treat this as an involuntary conversion despite the $900,000 profit. If you qualify, you can apply your old $100,000 tax basis to a replacement home. That means you don’t need to pay taxes on that $900,000 profit until you eventually sell it. Replacement House. To defer a casualty gain by reinvesting insurance or lawsuit proceeds, the replacement property typically must be purchased within two years. First the year in which Any Part of the casualty benefit is recovered. For a federally declared disaster, the period is extended to four years. See Which property is eligible for involuntary conversion tax relief?
However, watch out for insurance recovery, which can come long before the lawsuit is settled. If your insurance company paid you enough money to make up even $1 of the taxable gain on your destroyed property, the clock has already begun for getting the replacement property. Another big issue is claiming casualty damages. As of 2018, many taxpayers could claim a casualty loss on their tax return. But starting in 2018 and continuing through 2025, casualty damages are only allowed if your loss was the result of a federally declared disaster. Many fire victims in California qualify, as most major California wildfires are a federally declared disaster. Even so, it may still take some careful planning and guesswork in determining whether claiming damages is a good move.
Another tricky issue is how to handle expenses for temporary housing and similar expenses. If your primary residence is damaged or destroyed, your sum insured may be partially tax-free for the purpose of compensating for your living expenses. Examples are replacement housing and meals. But, if the sum insured pays you for living expenses then you will have generally If your home was not damaged, such as your mortgage payment or your typical meal expenses, that portion may be taxable. revenue To you. If insurance income exceeds the actual amount you spent on temporary housing, food, and other living expenses, that surplus may also be taxable.
As these examples show, even dealing with insurance income raises many finer tax issues. Clearly, however, the tax stakes and issues with litigation recovery can be sizable. How will that be taxed for the victims that ultimately lead to a legal settlement or decision? Fire recovery is highly factual, so issues are complicated to assess How is a fire recovery tax levied?, Some fire cases involve wrongful death, and compensatory wrongful death damages are tax-free. Punitive damages are always taxable. Some victims experience bodily injury or physical illness, either caused by or exacerbated by the fire. Fortunately, Section 104 of the Tax Code excludes loss of income for personal bodily injuries or physical illness. The loss must be physical, not just emotional, for money to be tax-free.
Health problems caused by smoke inhalation or aggravation of pre-existing medical problems may be enough to cause tax-exempt damages. Some of the drawings required by tax law may seem artificial. Most emotional distress damages are fully taxable, but emotional distress resulting from physical injury or physical illness is tax-exempt. it can make Taxing the loss of emotional distress and physical illness can seem like a chicken or an egg. issues.
The major object in most fire cases is property damage or destruction. It can be a multifunctional object, consisting of a house, outdoor buildings, trees and shrubs, crops and more. It is also important to consider the actions of the taxpayer. Are you rebuilding or moving away? This will all play into how the IRS will tax the fire victim. If you don’t reinvest, you could have a sizable capital gain, claiming a primary residence tax benefit of up to $500,000 if you qualify. If you’re selling a primary residence and qualify, the first $500,000 in profit for a married couple filing jointly must be tax-free. The remaining amount should be taxed as capital gain. But keep in mind that this is only a federal tax benefit. When it comes to California taxes, remember that all income is taxed at up to 13.3 percent, so capital gains are also no bargain.
Obviously, many fire victims expect that they won’t incur any taxes when they collect money from their insurance company or PG&E or Edison. If they are moving their income into buying a new home or rebuilding, they may end up with a lower basis in the new home, but this will mean paying taxes when they eventually sell their home. . But there can be some surprising alliances in matters of fire that are important to avoid. As with any fire recovery, pay close attention to timing and details. When it comes to taxes, like fire, be careful out there.
Credit: www.forbes.com /