How the New Tax Law Could Slow Disaster Recovery in Small Towns

Feb. 16--Since Congress passed its sweeping tax overhaul in December, considerable attention has been paid to new rules around mortgage interest deductions and state and local tax deductions -- both of which could have serious implications for taxpayers and state and local revenue streams.

But one substantial shift has gotten somewhat lost in the shuffle: a change to what are known as "casualty loss" deductions, which filers can claim when they're hit by a major, unexpected disaster. It's not just for victims of natural disasters like one of the several hurricanes to hit the U.S. last year. It's also for victims of smaller disasters like car crashes, house fires and floods.

Until now, that is.

Starting next year, when Americans file their 2018 taxes, only victims of presidential-declared disasters qualify for casualty loss deductions. Presidential-declared disasters are the kind that receive assistance from the Federal Emergency Management Agency (FEMA) under the Stafford Act, which regulates federal assistance to state and local governments suffering from a disaster they can't handle on their own.

Last year, the president declared 137 disasters across the country, from severe winter storms to mudslides to hurricanes to wildfires.

Experts in natural disaster recovery say this could have a substantial effect on people and could negatively impact small communities affected by a disaster that doesn't meet the threshold for FEMA assistance.

"The casualty loss deduction has been one of the single most important sources of funding for your average middle-class person who is affected by a catastrophic disaster when that disaster is not widespread," says Ed Thomas, president of the Natural Hazard Mitigation Association and a previous FEMA employee, where he worked on about 200 disasters.

"You'll have a small tornado or an urban fire, for example. So often we'll see a small situation, with a half a dozen buildings affected, and yet for the individuals involved it's just as catastrophic as Hurricane Harvey or Hurricane Katrina," he says.

Thomas points to the case of Harpers Ferry, W.Va. After a fire destroyed nearly 10 structures in the town in 2015, the federal government declined to offer any aid. At least eight businesses were destroyed, a devastating blow for a small town.

Harpers Ferry is far from alone.

In 2013, a fire in Yarnell, Ariz., destroyed 109 homes and killed 19 firefighters, but the city did not qualify for FEMA assistance. In 2008, a rainstorm dropped 15 inches on the Texas city of Roma, causing $1.3 million in damages, but FEMA declined to provide assistance. Also in Texas, neither Hurricane Humberto in 2007 nor Hurricane Hermine in 2010 qualified for disaster declarations, despite appeals from Gov. Rick Perry.

In cases like these, Thomas says the elimination of the casualty loss deduction could have widespread consequences.

"You'll have several people or businesses who previously could have taken a deduction that are no longer going to have that option," he says. "That could easily have trickle-down effects on the whole community because there's just going to be less money coming in."

A large number of people take advantage of the casualty loss deduction every year. A total of 72,323 filers claimed casualty loss deductions in 2015 -- the last year for which data is available -- according to the Internal Revenue Service. In California alone, 10,000 filers claimed a total of $700 million in these deductions in 2015, according to H.D. Palmer, deputy director for the California Department of Finance. The IRS, however, does not separate data according to which filers were affected by presidential-declared disasters.

Some tax experts, however, believe that the new provision -- which expires in 2025 but could be renewed -- won't have much of an effect on individuals and will have no real impact on municipalities.

"I think the impact is going to be minimal. You still have people qualifying in presidential disaster zones, and the deduction was already pretty limited to begin with," says David Brunori, a tax lawyer at Quarles and Brady.

Brunori points out that even in the old tax code, you could only deduct if your losses were 10 percent or more of your adjusted gross income, and you had to subtract any insurance reimbursement you received.

"That's a big one because most people have insurance. If you have something really valuable, you probably have it insured," he says.

Thomas sees things differently.

"Folks who are small taxpayers, who are low-income, they are the people who may not have insurance," he says. "Small business owners are confronted with tough choices. Do I give somebody a raise, or do I buy the insurance that I really need?"

Natalie Delgadillo -- Web Producer -- ndelgadillo@governing.com -- @ndelgadillo07

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