The Taxman Cometh After Road Home Grants

You’ve probably heard about the Road Home grants program—the government funded program by which victims of the post-Katrina Great New Orleans Flood can receive grants to rebuild or have their properties bought out, created as a government apology for not keeping the levee system up to snuff.

It sounds like a few folks haven’t thought about the tax implications. From the NOLA Times-Picayune blog:

The Internal Revenue Service would normally treat Road Home grants as nontaxable gifts, but if the grant applicant claimed a casualty loss from the 2005 hurricanes and later gets the Road Home compensation, the IRS considers the grant a duplication of the 2005 tax break, and it becomes taxable income in the year it’s received.[...]

For example, [accountant Jerry Schreiber] said if Social Security recipients claim sizable casualty losses and then get large Road Home grants, they could go from not having to file a federal tax return to having to pay taxes on all their income: their pension and their grant. “When you lose your world and your comfort zone, it’s very difficult,” Schreiber said. “This is the emotional toll of all of this. And it’s why it’s so, so difficult to get people to pay attention to the tax issue. It comes in now, along with everything else: the insurance companies, the LRA, whether the levees are rebuilt. It’s too much for a lot of people.”

When I first encountered this story, I was bracing for yet another example of the IRS being a bit too hungry in its interpretation of tax law. If you got a tax break from claiming a casualty loss and that loss is mitigated, that break ought to be unwound if fairness is to be preserved.

Given the uncertainties that existed in the wake of Katrina and with the reconstruction programs, it would be appropriate to allow a gradual unwinding of that tax break. Some accountants are recommending that folks with Social Security income try to take the Road Home grant payments in installments spanning a couple of years, to avoid hitting the income level that triggers Social Security payment taxability. Personally, I think a point could be made for lobbying for a mechanism to let folks “un-take” the casualty tax break.

However, the idea of letting folks receive the grants tax-free even if they claimed the loss on their income…while many recipients could definitely use the help, it seems unfair to reward them just because they didn’t read the instructions.