December 2010 Dec Page
Question of the Month
Property coverage forms commonly contain exclusions for loss caused by governmental destruction, confiscation, or seizure of property. However, a denial of coverage based on these exclusions is not automatic. For example, some property forms, such as the commercial property forms and the ISO homeowners policy, mitigate the effects of the exclusions by stating that actions taken by the government to stop the spread of fire fall outside the scope of the exclusions. Moreover, the exclusions, as is usual, are subject to judicial interpretation.
Since the governmental action exclusion is not ironclad, how can the insured know when a loss due to governmental authority is covered by his property policy? The best way is through an examination of the case law on the subject. The Governmental Action article discusses the application of the exclusion as found in various court cases. For the most part, courts have upheld the exclusion, but the courts also rein in an overly-broad reading of the exclusion to make its application more reasonable. This article examines the exclusion and its interpretation in different jurisdictions based on the language in both commercial and personal lines policies.
Chinese Drywall Information
The IRS will allow individuals who have used corrosive drywall building materials to treat related losses as a deductible casualty loss. Revenue Procedure 2010-36, 2010-42 IRB provides the guidance.
Many homeowners have experienced problems with certain imported drywall installed in their homes between 2001 and 2008. Homeowners have reported blackening or corrosion of copper electrical wiring and copper components of household appliances, as well as sulfur gas odors. In November 2009, the Consumer Product Safety Commission (CPSC) reported that an indoor air study of a sample of fifty-one homes found a strong association between the problem drywall and levels of hydrogen sulfide in those homes, as well as corrosion of metals. See http://www.cpsc.gov/info/drywall.
The IRS has received many inquiries about whether a loss from corrosive drywall constitutes a deductible casualty loss under IRC Section 165; the taxable year any such loss would be deductible; and how the amount of the loss would be computed.
Individuals generally may deduct losses incurred during the taxable year that are not compensated by insurance or otherwise. For personal-use property (such as a personal residence and household appliances), the deduction is normally limited to losses from fire, storm, shipwreck, or other casualty, or from theft. A casualty loss is damage, destruction, or loss of property that results from an identifiable event that is sudden, unexpected, and unusual. Damage or loss resulting from progressive deterioration of property is not a casualty loss.
A casualty loss normally may be deducted only for the taxable year in which the loss is sustained. However, if the taxpayer has a claim for reimbursement of the loss (from insurance or otherwise) for which there is a reasonable prospect of recovery, no portion of the loss is deductible until it can be determined with reasonable certainty whether such reimbursement will be received.
The amount of a taxpayer's casualty loss generally is the decrease in the fair market value of the property as a result of the casualty, limited to the taxpayer's adjusted basis in the property. To simplify the computation of a casualty loss deduction, IRS regulations permit taxpayers to use the cost to repair the damaged property as evidence of the decrease in value of the property. See Treasury Reg. Section 1.165-7(b).
IRC Section 165(h) imposes two limitations on casualty loss deductions for personal use property such as a personal residence. First, a casualty loss deduction is allowable only for the amount of the loss that exceeds $100 per casualty ($500 for taxable years beginning in 2009 only). Second, the net amount of all of a taxpayer's casualty losses (in excess of casualty gains, if any) is allowable only for the amount of the losses that exceed ten percent of the taxpayer's adjusted gross income (AGI) for the year.
Although losses incurred from corrosive drywall is not “sudden” as normally required, in view of the unique circumstances surrounding such damage, the IRS will provide a safe harbor method (or a special tax break) that treats certain damage resulting from corrosive drywall as a casualty loss. The IRS also provided a formula for determining the amount of the loss. To qualify, see the following specific procedures.
An individual who pays to repair damage to that individual's personal residence or household appliances that results from corrosive drywall may treat the amount paid as a casualty loss in the year of payment. Note that prior year returns may be amended. The term “corrosive drywall” means drywall that is identified as problem drywall under the two-step identification method published by the CPSC and the Department of Housing and Urban Development in their interim guidance dated January 28, 2010.
The amount of a loss resulting from corrosive drywall may be limited depending on whether the taxpayer has a pending claim for reimbursement (or intends to pursue reimbursement) of the loss through property insurance, litigation, or otherwise. A taxpayer who does not have a pending claim for reimbursement (and does not intend to pursue reimbursement) may claim as a loss all unreimbursed amounts paid during the taxable year to repair damage to the taxpayer's personal residence and household appliances. A taxpayer who has a pending claim for reimbursement (or intends to pursue reimbursement) may claim a loss for 75 percent of the unreimbursed amounts paid during the taxable year to repair damage to the taxpayer's personal residence and household appliances that resulted from corrosive drywall. A taxpayer who has been fully reimbursed before filing a return for the year the loss was sustained may not claim a loss. A taxpayer who has a pending claim for reimbursement (or intends to pursue reimbursement) may have income or an additional deduction in later taxable years depending on the amount of reimbursement received.
Amounts paid for improvements or additions that increase the value of the taxpayer's personal residence above its preloss value are not allowed as a casualty loss. Only amounts paid to restore the taxpayer's personal residence to the condition existing immediately prior to the damage qualify for loss treatment.
If a household appliance is replaced rather than repaired, the amount of the loss attributable to the appliance is the lesser of the current cost to replace the original appliance or the basis of the original appliance (generally its cost).
Individuals claiming such a casualty loss must report the loss amount on Form 4684 (Casualties and Thefts) and mark “Revenue Procedure 2010-36″ at the top of the form. Taxpayers are still subject to the $100 ($500 for taxable years beginning in 2009 only) limitation, and the 10-percent-of-AGI limitation.
And, those who choose not to apply the safe harbor treatment are subject to all of the generally applicable provisions concerning deductibility of losses under IRC Section 165. These taxpayers must establish that the damage, destruction, or loss of property resulted from an identifiable event that is sudden, unexpected, and unusual, and was not the result of progressive deterioration. These taxpayers also must prove that the loss is properly deductible in the taxable year claimed by the taxpayer and not in some other year. Further, these taxpayers must prove the amount of the claimed loss, and must prove that no claim for reimbursement of any portion of the loss exists for which there is a reasonable prospect of recovery.
Latest Status Report
The U.S. Consumer Product Safety Commission (CPSC) provides status reports on new developments in the investigation of imported drywall. The following is the latest status report from the CPSC.
This update describes new developments in the ongoing investigation of imported drywall and supplements the previous reports provided to the Committee. As of September 22, 2010, the U.S. Consumer Product Safety Commission had received 3,602 incident reports related to drywall from 38 states, the District of Columbia, Puerto Rico, and American Samoa . More than 90 percent of reports are from five states: Florida (57 percent), Louisiana (19 percent), Mississippi (7 percent), Alabama (6 percent), and Virginia (4 percent).
In addition to the consumer reports on drywall received by the CPSC, the outreach efforts and investigations have secured information from many other sources, including state governors, county governments, importers, builders, distributors, installers, and other parties in the drywall distribution chain. Combining the information from all sources and eliminating duplicates, the best estimate of the number of homes that have registered complaints about drywall is approximately 6,300.
The CPSC has been providing these Congressional updates on a monthly basis since the early days of the investigation. As CPSC wraps up its scientific investigation, it will continue to report the findings on www.DrywallResponse.gov and issue these updates to Congress on a quarterly basis, with the next update at the end of the first quarter of fiscal year 2011.
Assistance to U.S. Army Investigation at Fort Bragg: The CPSC is assisting the U.S. Army in the investigation of the deaths of infants reported by families at Fort Bragg, North Carolina , by providing an independent, comprehensive investigation into environmental factors in certain homes. The CPSC's contractor, Environmental Health & Engineering (EH&E), is conducting a comprehensive investigation of the indoor environment of two houses at Fort Bragg .
Additional Indoor Air Testing in Homes with Non-Chinese Drywall: In addition to the indoor air testing at Fort Bragg, EH&E is also conducting indoor air testing focused on drywall-related issues in a small number of homes where consumers have reported problems with non-Chinese manufactured drywall. Although these reports of homes alleging problems due to non-Chinese drywall represent a very small fraction of the total reported incidents, the CPSC is investigating them as part of the overall investigation to gain a comprehensive understanding of the reported problems. Results from these studies will not be available until winter.
IRS Casualty Loss Guidance: On September 30, 2010, the Internal Revenue Service (IRS) issued guidance providing relief to some homeowners who have suffered property losses due to the effects of imported drywall installed in homes between 2001 and 2009. Revenue Procedure 2010-36 enables certain affected taxpayers to treat damages for faulty drywall as a casualty loss and provides a safe harbor formula for determining the amount of the loss.
CPSC continues to investigate long term corrosion on electrical and fire safety components under contract with other federal
laboratories. Initial results of analyses of components exposed to corrosive conditions are expected this autumn. Through this work, the Commission hopes to fine-tune the Interim Identification Guidance and Interim Remediation Guidance (in conjunction with the U.S. Department of Housing and Urban Development). To date, this has been the largest compliance investigation in agency history.
Choice of Law Rule in Workers Comp Dispute
A substantive conflict occurred between the workers compensation plans of Alabama and Mississippi when a worker was injured in Mississippi while working on a construction site for an Alabama employer. This case is Ellis v. Trustmark Builders, Inc., 2010 WL 4260778 (C.A. 5, Miss.).
Ellis was injured while working in Mississippi . He recovered workers compensation benefits from Alabama under his employer's policy which included coverage for work sites in Mississippi . Ellis then filed a tort action for damages alleging negligence against Trustmark Builders. The district court applied Mississippi choice of law principles and held that Mississippi 's workers comp plan governed the lawsuit and this barred Ellis from bringing tort claims against the builder. Ellis appealed.
The circuit court took note of the fact that Ellis is a resident of Mississippi and the other parties involved in the lawsuit are Alabama residents. Mississippi workers comp law provides the exclusive remedy for an injured worker; suits against co-employees or an employer for damages are generally barred. The Alabama workers comp statutes permit a lawsuit against a co-employee or employer whose negligence causes the injury. The circuit court had to decide which state law governed the case.
The court looked to the relevant section of the Restatement (Second) of Conflict of Laws. That section directed that tort actions should be governed by the law of the state with the most significant relationship to the occurrence and the parties. The section also suggested these types of contacts that should be considered in the determination of which state law prevails: the place where the injury occurred; the place where the conduct causing the injury occurred; the domicile, residence, or place of incorporation and place of business of the parties; and the place where the relationship between the parties is centered.
It was clear in this case that both the injury and the allegedly negligent conduct that caused the injury took place at the construction site in Mississippi . However, the court said that this is not dispositive of the case because the Restatement also made clear that, for personal injury actions, if some other state has a more significant relationship, that point prevails. In this instance, Mississippi did not have an interest in workers compensation because Ellis had already received protection from Alabama pursuant to its workers comp law. Moreover, the employer was centered in Alabama, all parties other than Ellis are Alabama residents or corporations, and the employer took out and maintained Alabama workers comp insurance. These facts satisfied the circuit court that Alabama had a more significant relationship to the case than did Mississippi, especially since the parties have already engaged Alabama 's workers compensation system.
The Restatement required deferring to the state with the most significant relationship to the particular issue in dispute. When assessing whether a workers comp law should afford tort immunity to parties, the important state ties are naturally with the state where the employment relationship is centered, and particularly the state where the employer provides workers compensation insurance coverage and the employee has already received such benefits for the injury at issue. In this case, the court ruled, Alabama is that state. Ellis's tort action should be governed by Alabama 's workers compensation law and that law allows Ellis to pursue his tort action. The ruling of the district court was reversed.
Editor's Note: This case is presented as an example of how choice of law disputes can be settled. The Restatement (Second) of Conflict of Laws offers guidelines for courts to use when deciding which state law prevails, and this decision can be the main factor in determining which party wins the legal argument. But for all the guidelines and factors set out in the Restatement, the bottom line is that the state with the most significant relationship to the particular issue in dispute should be the state whose law is followed, and this point is determined by the particular facts of the case.