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Tuesday, July 20, 2010

Tax Issues and the Gulf of Mexico Oil Spill: Legal Analysis of Payments and Tax Relief Policy Options

Molly F. Sherlock
Analyst in Economics  

Erika K. Lunder
Legislative Attorney  

Edward C. Liu
Legislative Attorney  

Heather S. Klein
Research Assistant

The explosion of the Deepwater Horizon oil rig and subsequent oil spill into the Gulf of Mexico has led to substantial damages, particularly in the form of lost wages and income. BP has begun to make interim payments to compensate for lost income resulting from the oil spill. Given the magnitude of the economic disruption resulting from the spill, however, policymakers may consider exploring alternative mechanisms for providing relief to the affected region. One option is to provide relief through the tax code by adopting measures similar to those employed following past major disasters.

BP is currently making interim payments to claimants "who are not receiving their ordinary income or profit" during the cleanup phase. The IRS has released guidance regarding the tax treatment of these payments in an effort to help taxpayers understand the tax implications of receiving claims payments from BP. This report provides a legal analysis of the tax status of payments received from BP by Gulf Coast victims under current law, and discusses potential legal distinctions between payments received for lost income versus those that may be received to compensate for property loss and physical injuries. Further, this report comments on the tax implications in the event a federal disaster declaration is issued with respect to this incident.

In the past, Congress has used the tax code as a tool to provide relief to disaster victims. While the Gulf of Mexico oil spill has not been classified as a federally declared disaster, the tax code could be used as a mechanism for delivering additional relief. Policy options that could be explored include added casualty loss deductions, an extended net operating loss (NOL) period, employment incentives, enhanced access to retirement savings, and incentives for charitable relief. Similar policies were adopted following past disasters.

The oil spill in the Gulf of Mexico presents lawmakers with unique challenges in using the tax code to provide relief. First, the oil spill is not a natural disaster. The oil spill is the result of human action where, unlike a natural disaster, compensation may be recovered from a financially responsible party. Second, the nature of the damages is different from those typically borne by victims of natural disasters. Specifically, damages may primarily be in the form of lost business income and employment, rather than direct property loss. Relief that has been awarded in the past, such as tax filing extensions to assist with the destruction of taxpayer records, is not likely to be an issue. Finally, if the goal is to provide relief or assistance to the poor, the tax code may not be the best policy instrument.

Legislation has been introduced in the House and is being discussed in the Senate that would provide tax relief to the Gulf Coast oil spill victims. The Oil Spill Tax Relief Act of 2010 (H.R. 5598) would require that any compensation provided by BP to an oil spill victim be treated as a qualified disaster payment, and thereby excluded from gross income for tax purposes. The Gulf Coast Access to Savings Act of 2010 (H.R. 5602) would allow for enhanced access to retirement savings. The Gulf Oil Spill Recovery Act of 2010 (H.R. 5699) would make various tax relief measures available to businesses and individuals. Senate discussions include proposals similar to what has been introduced in the House, as well as a tax holiday for tourism-related activities.

Date of Report: July 15, 2010
Number of Pages: 18
Order Number: R41323
Price: $29.95

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