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Oil spill-related assistance from BP may be taxed

MISSISSIPPI GULF COAST — Gulf Coast business owners who receive payments from BP for oil spill-related losses may also get an unwanted surprise: The money isn’t all theirs to keep. Many will have to pay taxes on the payouts just as they would with some insurance proceeds.

Last Friday, the IRS issued what it called guidance, or tax information, for businesses and individuals affected by the spill. While the government was focusing on victims of the spill, the information applies to any business that has received compensation after a disaster.

Among other things, the IRS said that payments intended to replace a business’ lost income or profits must be reported as part of a company’s gross income. And a self-employed business owner is required to pay self-employment taxes on the money.

The IRS said it would hold what it’s calling Gulf Coast Assistance Day July 17 to help taxpayers and tax preparers with issues related to the spill. IRS employees will be available in Mobile, Ala.; Panama City and Pensacola Fla.; New Orleans, Houma and Baton Rouge, La.; and Gulfport. The IRS said times and specific locations would be available soon on its website, www.irs.gov.

The IRS site also has information about tax matters related to the oil spill.

BP PLC has agreed to set up a $20 billion claims fund to compensate individuals and businesses who have suffered losses due to the spill, which began after an April explosion and fire sank a BP-operated rig. Among the businesses that have submitted claims are shrimpers, fishing industry suppliers and resort hotels, all of which have seen their income plunge or even disappear because of the spill. BP’s website, www.bp.com, has information on filing claims.

A look at the tax issues involving the BP payouts:

LOST INCOME AND PROFITS

The IRS’ guidance on oil spill payouts comes from some basic, decades-old provisions of the tax law.

“There are no new rules, no special treatment” because of the spill, said Ralph Litolff, a certified public accountant and director of business consulting services with Bourgeois Bennett LLC in Metairie, La.

Under the law, any payments that a business or a company owner gets to replace lost income or profits are taxable. Typically, those payments are from business interruption insurance policies or court awards, but the oil spill payments fall into the same category when it comes to how they’re treated by the tax laws. What matters is the purpose of the payout rather than the source of the money.

The theory behind the law is simple. A business or owner would have to pay tax on what they would have earned if a disaster or other event hadn’t stopped them from making money.

“If the ultimate plan of the payment is to replace what would have been income, it’s generally taxable,” Litolff said.

Business owners who are self-employed will also have to pay self-employment taxes on the payout. These include Medicare and Social Security taxes. They may also need to pay estimated tax on the payments, to avoid late payment interest when 2010 returns are due next April.

PROPERTY DAMAGE

The oil spill compensation fund also covers payments for property damage from the spill. But, unlike payments to cover lost income, businesses don’t have to pay taxes on the money they receive for damage to their property. This is also long-standing tax law. The theory is that payments are making injured parties whole again.

Litolff said that compared with disasters like hurricanes, the oil spill has resulted in relatively few cases of business property damage. If fishing boats or docks are covered by oil, BP says it will pay for the cost of cleaning them up. The same goes for any private beachfront property, including property used for business purposes, where oil washes ashore.

Litolff said he has gotten calls from people who own beachfront condos who are seeing their property values fall. At this point, he said, those property owners won’t qualify for payments from BP unless they can prove property damage. And there’s no tax relief, although there might be if the property is sold at a loss.

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About Megan Wright