California fires: Accelerated disaster relief tax provisions

ARTICLE | January 10, 2025

Authored by RSM US LLP

Executive summary: California fires disaster relief and relevant tax provisions

Business and individual taxpayers affected by the California wildfires may benefit from various relief provisions in the Internal Revenue Code. These provisions include the ability to:

• Deduct casualty losses.
• Make a disaster loss election to claim losses in the preceding tax year.
• Make tax-free qualified disaster relief payments to employees.
• Qualified wildfire relief payments

These measures aim to provide timely tax relief and support for those impacted by federally declared disasters. President Joe Biden on Jan. 7, 2025, declared the California fires to be a major disaster.

Business and individual taxpayers affected by the California wildfires may be able to benefit from various relief provisions in the tax code. Here’s what to know about the various provisions, what disasters qualify, and why taxpayers may wish to take advantage of these relief provisions.

Casualty losses

In general, a taxpayer can deduct losses when property is damaged or destroyed in a casualty. To measure the potential loss, a taxpayer should determine their cost basis of the property, adjusted for any deductions, and then determine the decline in fair market value of the property as a result of the casualty. The potential loss is the lesser of those amounts.

Insurance recoveries also come into the equation, as the loss must be reduced by the amount of any insurance proceeds received or expected to receive.

Personal casualty losses sustained in a federally declared disaster area, such as the loss of a residence, are generally allowed to the extent the loss exceeds 10% of adjusted gross income (AGI). However, if the disaster is considered a qualified disaster, this so-called AGI floor is not applicable and, if the loss exceeds $500, a taxpayer may take such loss as a deduction to their income. The California wildfires are considered a qualified disaster for which the AGI floor is eliminated since this disaster occurred by Jan. 11, 2025, and it was presidentially declared by Feb. 9, 2025.

Individual taxpayers will be allowed to claim this type of casualty loss “above the line,” meaning even if they don’t itemize their deductions, they can still take the casualty loss in addition to the standard deduction.

Disaster loss election

A taxpayer may make an election to take a loss attributable to a federally declared disaster in the tax year immediately preceding the disaster tax year. This election may allow a taxpayer to receive tax relief much earlier than for the disaster tax year.

The window for this election is limited. The deadline for making a section 165(i) election is six months after the due date for filing the taxpayer's federal income tax return for the disaster year (determined without regard to any extension of time to file). The election is made on Form 4684, Section D, Part 1.

Example 1: In January 2025, John, an individual taxpayer, sustains a casualty loss in the amount of $1.3 million. As the casualty loss occurred in 2025, John generally would claim such loss deduction on his 2025 income tax return, which he plans to timely file on the original due date of April 15, 2026.

However, as the loss of $1.3 million occurred in a federally declared disaster area and was attributable to the disaster, John instead makes an election to claim the casualty loss on his 2024 federal income tax return. John is able to reduce his adjusted gross income by $1.3 million and timely files his federal income tax return on the original due date of April 15, 2025.

Example 2: In January 2025, WidgetCo, a corporation, has a casualty loss in the form of inventory destroyed in a wildfire. The cost of the inventory to WidgetCo was $25 million. The company intends to make a disaster loss election with its 2024 federal income tax return, which it will file on Oct. 15, 2025.

As a result of the election, WidgetCo reduces its April 2025 extension tax payment to account for the additional loss to be claimed on the 2024 income tax return. As the disaster property relates to inventory, WidgetCo will adjust its 2025 purchases so as not to double-deduct the amounts in 2024 and 2025.

In both examples, each taxpayer is able to obtain a form of tax relief (reduced taxable income) on their 2024 income tax return and accelerate the relief by a full year.

Qualified disaster relief payments

Employers can make direct payments to affected employees that are not taxable if the requirements for qualified disaster relief payments under section 139 are met.

The disaster must be a presidentially declared disaster, usually found as a major disaster on the Federal Emergency Management Agency (FEMA) website. If the disaster is qualified, the payments from an employer to affected employees that meet certain criteria (such as not being covered by insurance) are not treated as wages and are excludable from federal income tax, employment taxes and Form W-2 reporting. Because state laws vary, the payments may or may not be excluded from state income tax.

Qualified wildfire relief payments

The legislation enacted in mid-December 2024 allows taxpayers to exclude from gross income all compensation for losses or damages resulting from qualified wildfires relief payments.

Qualified wildfire relief payments include any amount received as compensation for losses, expenses or damages if losses arose from a qualified wildfire disaster and were not compensated by insurance or otherwise. This includes compensation for:

• Additional living expenses
• Lost wages (other than compensation for lost wages paid by the employer which would have otherwise paid such wages)
• Personal injury
• Death or emotional distress

A qualified wildfire disaster is any federally declared disaster resulting from any forest or range fire. This provision applies to qualified wildfire relief payments received by or on behalf of an individual during taxable years beginning after Dec. 31, 2019, and before Jan 1, 2026.

Taxpayers should note that this legislation prohibits a double benefit—no deduction or credit shall be allowed for any expenditure to the extent the amount was excluded from income. If a taxpayer uses these qualified payments to acquire or improve property, the taxpayer cannot increase their basis in the property. 

Qualified disasters are those that the president declares as a disaster under the Robert T. Stafford Disaster Relief and Emergency Act. In addition, personal casualty losses for which the AGI floor is eliminated are presidentially declared disasters occurring between Jan. 1, 2020 and Jan. 11, 2025 (if declared by Feb. 9, 2025).

Claiming disaster relief

Business and individual taxpayers seeking disaster relief from the California fires should work with a tax advisor that has extensive experience with disaster relief tax provisions.

In addition, the IRS has published several resources that may support your course of action:

• Disaster assistance and emergency relief for individuals and businesses | Internal Revenue Service
• Publication 547 (2023), Casualties, Disasters, and Thefts | Internal Revenue Service

An experienced advisor can help you put those resources to use in navigating the relief process.

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