Understanding Disaster Qualification (Part 3 of 2)

Yes, we told you this would be a two-part series on how to handle Disaster Qualification from a tax standpoint and how to get your best deal. Several readers contacted me and said I hadn’t done a great job explaining “why” you’re better off filing Form 4684 as soon as possible, rather than waiting for your event to become “Qualified”, so I thought I’d spend just a little more time on the subject, so, yes, this is Part Three of Two.

Quick catch-up: Qualified Disasters are declared by an act of Congress. They get better tax treatment because you don’t need to subtract 10% of your income from the deduction and you can file with the standard deduction, rather than itemizing typically resulting in slightly more recovery. That “Act of Congress” needs to happen within 3 years of the filing date associated with the disaster. Some people choose to wait for Qualification because of the better treatment. Some don’t. Let’s find out how their experience differs.

Meet Tom and Bob. They both make about $100K per year, are married and bought their homes at the around the same time for about the same price. They live next door in Florida and were victims of Hurricane Ian. Both their houses suffered major damage in the storm. When tax season rolled around, they had a decision to make – File Form 4684 or wait for the storm to be Qualified so they might get better tax treatment. Based on their incomes, the pre and post value of their homes, they are entitled to a $50,778 benefit right away as part of their 2022 taxes. We’re going to simplify things a bit, but here’s how it might go.

Tom’s CPA told him to wait for Qualification. Bob’s tax-guy said to file immediately.

How will they both make out?

Bob filed his taxes, collected his $50,778 put the money to work rebuilding his house.

Tom, also short on cash for rebuilding, took out $50,000 in loans at 5% to help him rebuild.

In 2023, Several bills were filed in Congress to “Qualify” Ian, but so far later, none have succeeded. They have until 2025 to succeed.

We now need to get out our Magic 8-Ball and try to see if it’s possible for any of the qualification bills to succeed.

Hmmm… “Reply Hazy”. Typical.

OK, using our patented Quantum Reality Splitter we will split the universe into two timelines and see what happens.

Timeline 1 – Ian is qualified in early 2025 with just enough time to amend 2022, 2023 and 2024 taxes.

Bob’s accountant takes a look at his tax situation. In order to amend three years’ worth of taxes, it will cost him $1,500 ($500 per year). If he does this, he’ll get back an extra $474. Bob does some quick maths(1) and determines it’s not worth it. He would actually lose $1,026 by amending. He’s happy with his almost $53K in benefit and interest savings from not having taken any loans.

Tom’s accountant calls him and tells him the great news --  it’s time to amend the three years of taxes so he can finally get his money.  More good news, instead of getting $50,778 like Bob, he’ll get $51,252 - $474 more because he waited!  This should allow him to pay off those loans!

Let’s see how this works out for Tom:

                        Benefit from amending:                             $ 51,252

                        Cost of amending 3 years:                         ($ 1,500)

                        Loan Interest over 3 years:                       ($ 2,508)

                        Total:                                                             $ 47,244

In the end, waiting has cost Tom $5,542.

That’s bad, but it could have been worse. What if Ian was never Qualified?

Timeline 2 – Ian is never Qualified

In this timeline, Tom is waiting for Ian to be Qualified, but it just never happens, so his accountant calls him in 2025 and tells him it’s time to file to get his $50,778 benefit. Unfortunately, this will mean amending three years of taxes at $500 each.

Here’s the tally in this scenario:

                        Benefit from amending:                              $ 50,778

                        Cost of amending 3 years:                         ($ 1,500)

                        Loan Interest over 3 years:                         ($ 2,508)

                        Total:                                                             $ 46,770

In this case, Tom is $6,016 worse off than Bob.

In both timelines:

Tom and Bob meet for a beer and discuss their “Ian experience.” They discuss what happened and Tom fires his accountant the next day.

Conclusion

Taxes and finance are tricky things. Add politics and acts of congress and you’ve got a lot of uncertainty.

But one thing is certain: You can file form 4684 as soon as you’re affected by a disaster and then amend later if you need to. In fact, if your disaster occurs from January to April, you can include it with your current taxes. if your disaster occurs after April 15th, you can amend your prior year's taxes and the IRS has committed to processing these filings faster so you get your money as quickly as possible.

This has several advantages:

1.      It gets the money in your hand quickly

2.      It helps you avoid interest on loans you might otherwise have taken out

3.      Depending on what happens, you might even avoid the cost of amending in the future, because it might not be worthwhile.

Everyone’s situation is different. Use our Free Tax Recovery Estimator complete with the “What If” scenario illustrator to find out what your best strategy is.

We’re happy to help, if you or someone you know has been affected by a Federal Disaster, please contact us.

(1)      Yep, I said it. MathS. If we’re gonna say “SportS” then we should say “MathS”. At least that’s what my British buddy says.