Agency officials say they hope Congress will change the law quickly. But for now they have no choice but to treat FEMA grants as income.
By JEFF HARRINGTON
Published October 27, 2004
After his Ruskin home severely flooded three times in less than 10 years, John Holmes found relief three years ago through a government grant to tear down his one-story house and rebuild it on the same spot on stilts.
The federal grant provided roughly $130,000, or 75 percent of the project's cost. What the 74-year-old widower never bargained on is paying income taxes on that money.
The Internal Revenue Service recently ruled that some $500-million a year doled out under federal disaster mitigation programs is taxable - possibly retroactively. Included is a hodgepodge of grants: money used to retrofit homes with tornado safe rooms or hurricane straps; money to rebuild flood-prone homes on stilts or higher ground; and grants to move homeowners whose properties are particularly susceptible to flooding.
Holmes, a retired toolmaker living off Social Security, was flabbergasted that homeowners like himself might face thousands of dollars in unexpected taxes.
"Whatever happened to compassionate conservatism?" he said.
The IRS agrees, and supports a bill in Congress that would reverse its decision. But short of that legislation making a quick trip to passage, it plans to start enforcing the rule this year.
The Federal Emergency Management Agency has doled out $383-million for about 1,300 projects under the three disaster mitigation programs affected this year; about $51-million of that went to just fewer than 100 projects in Florida.
It's exactly the kind of pre-emptive measures disaster planners have espoused for years. To make them taxable, they say, would be nothing short of a disaster for disaster victims.
"We're very concerned about this," said Gene Henry, hazard mitigation manager for Hillsborough County. "If you're taxed on (a mitigation grant) and you're on a fixed income ... that's obviously going to be quite a shock."
Henry, who is past president of the Florida Floodplain Managers Association, said many grant recipients struggle to pay higher property taxes and homeowners insurance after a project has increased the value of their home, let alone extra income taxes.
Dozens of bay area projects might be affected, along with some homeowners like Holmes who were approved for a grant several years ago and the money was doled out gradually.
Lori Hudson, FEMA coordinator for the city of St. Petersburg, oversees a dozen mitigation projects. The grants range from $50,000 to as much as $160,000, depending on the house and location.
FEMA sets aside mitigation money based on how much money it spends on each disaster. That means Florida could be in line for a windfall eventually because of unprecedented damage from four major hurricanes this season. Florida is expected to be the single largest recipient of future mitigation grants.
"It's going to be a good long time until we find out" how much Florida will get in grants, Hudson said. "And when we find out, we're going to have 90 days to get all the money spent."
Her dilemma: Who wants to accept a federal grant if it comes with the strings of a huge tax liability?
Chad Berginnis, chairman of the Association of State Floodplain Managers, said the threat of taxes is having a chilling effect on the disaster-proofing industry.
Berginnis fired off a letter to FEMA officials a few weeks ago, saying the IRS' ruling could result in "long-term damage" to hazard mitigation programs.
"Our members and others have reported that even mentioning to owners that they may have to claim mitigation grants as taxable income is enough to discourage them from even considering mitigation opportunities," Berginnis wrote.
Moreover, he called it "inconsistent" to have a taxation policy that recognizes disaster payouts from FEMA as tax-free but then ignores the benefits for federal assistance to reduce damage from occuring in the future.
An Internal Revenue Service representative said the tax issue has been confusing and haphazardly applied for years, so it quietly "clarified" its position in a June letter to officials with the FEMA.
"The law didn't change," IRS spokesman Mike Dobzinski said. "All this memorandum does is lay out the facts of what our position is at this point in time."
Some in the emergency preparedness industry wonder if the tax isn't another step in eroding the disaster mitigation program, which Congress has scaled back.
The IRS insists it doesn't like the effect of its ruling, but had no choice.
"In reading the existing statute - and we have looked at this from every possible angle - unless there is a specific exclusion, it is a taxable event," said Tara Bradshaw of the U.S. Treasury Department, which oversees the IRS. To alter that ruling, "we need Congress to act and we have urged them to act," Bradshaw added.
U.S. Sen. Kit Bond, R-Mo., this month introduced a bill that would ban taxes on federal aid for disaster mitigation.
"This makes no sense to tax specific government grants to prevent expensive disasters, especially when we went out of our way to ensure that disaster-relief payments to individuals recovering from a hurricane, flood, tornado or other natural disaster are not subject to income taxes," Bond said.
Rep. Mark Foley, R-West Palm Beach, is sponsoring a companion bill in the House.
Along with the IRS, FEMA and disaster mitigation officials across the country support the bill.
If Congress doesn't act by the end of the year, the IRS left open the possibility of recouping mitigation taxes due from previous years in addition to 2004. In a letter to FEMA, IRS chief counsel Donald Korb said a taxpayer's history "certainly will be taken into account as to whether any enforcement activity by the Service in this regard is warranted."
Bradshaw of the Treasury Department, for one, doesn't even want to entertain the nightmare scenario of trying to collect from years past.
"The definitive answer is: Congress needs to act," she said.
The Internal Revenue Service recently decided that grants are taxable under the following three programs within the Federal Emergency Management Agency (FEMA):
THE HAZARD MITIGATION GRANT PROGRAM: Money can be used for a variety of projects, from building safe rooms in tornado-prone areas to elevating houses in flood zones to hurricane-proofing homes with shutters and reinforced windows. FEMA has committed about $290-million in grants this year.
THE FLOOD MITIGATION ASSISTANCE PROGRAM: A small program that targets flood-prone properties. About $11-million has been committed this year.
THE PREDISASTER MITIGATION PROGRAM: A relatively new initiative to earmark mitigation money to an area prone to hazards before a catastrophe strikes. The government has committed $81-million to projects this year.
The federal outlay for the largest program, hazard mitigation grants, depends on the number and scope of catastrophes that strike each year. The government formerly pledged a 15 percent match to the program based on how much FEMA pays out in disaster assistance each year. Two years ago, that formula changed. The Bush administration wanted to cut the program and beef up spending on predisaster mitigation. In a compromise, Congress cut the matching formula for hazard mitigation grants in half to 7.5 percent. Given the unprecedented four-hurricane season and the millions FEMA is spending here, Florida is expected to be the single largest recipient of future mitigation grants.
