The explosion of the Deepwater Horizon oil rig and resulting oil spill in the Gulf of Mexico has caused substantial damage and raised many questions regarding the tax treatment of payments made to individuals and businesses from British Petroleum (BP) and its recently established claims fund. The IRS has made clear that individuals, self-employed individuals, and businesses must include amounts received as compensation for lost wages, lost income, and profits in grossincome. This letter is intended to explain the tax treatment of certain payments made as a result of the oil spill. Lost business income, wages, and profits. BP has begun making payments to individuals and businesses to compensate for lost income caused by the oil spill, particularly for lost wages and profits. The IRS has confirmed that payments received for lost business income, lost wages, or lost profits must be included in taxpayers’ gross income. However, payments made from BP to an individual to compensate for lost wages will not be wages for purposes of Social Security and Medicare taxes because it is not an actual payment for employment within the meaning of the law. As such, these payments will also not generally be subject to income tax withholding (unless backup withholding applies). However, if the payment is made by an employer to its employees, or by a third party to the employer’s employees to satisfy an obligation of the employer to its employees, then the payment may be subject to Social Security and Medicare taxes and income tax withholding.
Self-employed individuals. BP payments received by self-employed individuals may be considered “self-employment income” for purposes of the Self-Employment Contributions Act (SECA) and thus subject to SECA taxes. As such, self-employed individuals who receive payments that represent compensation for lost income of the individual’s trade or business should include the amount of the payment in their net earnings from self-employment for purposes of the self-employment tax, the IRS says.
Property damage. Taxpayers do not need to include in gross income payments they receive for property damage or destruction if the payments do not exceed the taxpayer’s tax basis in the property. If the payments exceed your basis in the property, however, you will realize gain for federal income tax purposes. You may also be able to claim a casualty loss deduction if payments you receive (including insurance proceeds or payments for damages), or expect to receive, are less than your adjusted basis in the property.
Taxpayer assistance. The IRS is encouraging taxpayers in the Gulf who may be having difficulty making tax payments, or who have collections issues, to contact the agency. The IRS has expanded its outreach efforts to provide additional help to taxpayers affected by the Gulf oil spill. Some relief actions that the IRS may provide include: postponing collection actions, being flexible regarding missed payments on installment agreements and offers-in-compromise for previously compliant taxpayers, considering a taxpayer’s current income and potential for future income when negotiating an offer-in-compromise, and accelerating levy releases.
Legislative relief. Congress has been contemplating a number of ways to provide tax relief for Gulf oil spill victims. Some legislation that has been introduced to provide such targeted relief include the following: The Oil Spill Tax Relief Act of 2010 (H.R. 5598) would require that any compensation provided by BP to an oil spill victim be treated as a qualified disaster payment, thereby excluding the payments from gross income for tax purposes. The Gulf Coast Access to Savings Act of 2010 (H.R. 5602) would provide for enhanced access to retirement savings, such as eliminating penalties on early withdrawals from 401(k)s and IRAs. Finally, the Gulf Oil Spill Recovery Act of 2010 (H.R. 5699) would make various tax relief measures available to businesses and individuals. Our office will keep you updated on Congress’s legislative relief efforts as they take shape.
For more information on the tax aspects of oil spill payments, and especially if you need assistance on how any of these provisions may apply to you, please contact our office. Also, the IRS has posted on its web site, www.irs.gov, information on the tax treatment to individuals and businesses receiving compensation for damages caused by the oil spill. We will continue to monitor all developments.
Sal Censoprano, ATA CRTP
Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.