CONTENTS INTRODUCTION I. CASUALTY LOSS DEDUCTIONS FOR INDIVIDUALS: THE ADMINISTRATIVE LIMITATIONS OF APPLYING I.R.C. [section] 165(c) TO THE VICTIMS OF OIL SPILLS II. CASUALTY LOSSES AND GENERAL DECLINE IN PROPERTY VALUE: AN ARGUMENT IN FAVOR OF ADOPTING THE ELEVENTH CIRCUIT'S APPROACH TO CASUALTY LOSSES FOR OIL SPILL VICTIMS III. A FLAWED FRAMEWORK: THE SHORTCOMINGS OF THE OIL POLLUTION ACT OF 1990, THE GULF COAST CLAIMS FACILITY, AND INSURANCE IV. THE STAFFORD ACT AND [section] 165(h)(3)(c): APPLYING THE CASUALTY LOSS PROVISIONS FOR VICTIMS OF FEDERALLY DECLARED DISASTERS TO VICTIMS OF OIL SPILLS V. REDUCING TRANSACTION COSTS AND STREAMLINING THE SYSTEM THROUGH IRS SUBROGATION CONCLUSION INTRODUCTION
The explosion on the Deepwater Horizon drilling rig on April 20, 2010, resulted in the spill of more than four million barrels of oil into the Gulf of Mexico. (1) The disaster was a result of human agency (2) and caused extensive damage to the economy of the Gulf states, the ecosystem, and the property of businesses and individuals in the areas affected. (3) President Obama called the spill "the worst environmental disaster America has ever faced," (4) and the oil affected approximately 650 miles of the Gulf Coast, with Louisiana being hit the hardest. (5)
This Note focuses on the tax treatment of casualty losses (6) to individuals affected by the Deepwater Horizon oil spill, as well as future oil spills and contamination disasters, under section 165(c)(3) of the Internal Revenue Code. Code section 165(c)(3) covers "casualty losses"--losses not connected with a trade or business or a project entered into for a profit and that arise from "fire, storm, shipwreck, or other casualty." (7) It is unclear whether section 165(c)(3) applies in the oil spill context, but this Note advocates that such spills should be treated as an "other casualty." (8) Utilizing the Code in a modified way to compensate victims of such disasters is a superior approach to the current framework for compensating victims of casualty losses stemming from oil spills. The current approach applies a combination of strict applications of section 165(c)(3), claims under the Oil Pollution Act of 1990 (OPA), (9) private claims processes set up by tortfeasor oil companies, and private causes of action by individuals and businesses against those oil companies. This Note argues that this current framework is disjointed, inefficient, and ought to be streamlined, and it suggests an alternative to the current approach: IRS subrogation with a removal of section 165(h) floors and an adoption of the Code section 165(i) election, through a modified understanding and application of Code section 165(c)(3), particularly as it pertains to the Robert T. Stafford Disaster Relief and Emergency Assistance Act (Stafford Act) (10) and the OPA.
Part I discusses the mechanics of Code section 165(c)(3). It explains the judicial history of this section of the Code, including the standard statutory interpretation approach that courts have used in light of the limited legislative history surrounding this provision. It also explains how casualty loss deductions are calculated, covering the burden of proof, the floors involved in calculating a casualty loss, and the social and political reasons for these limitations. It goes on to examine the meaning of this section of the Code itself, applying the rule of ejusdem generis ("of the same kind") to explore whether property damage caused by the Deepwater Horizon oil spill can or should be treated as a casualty loss, ultimately arguing that it should be treated as such. It also discusses the Tax Benefit Rule, a doctrine limiting casualty loss deductions to those "not compensated by insurance or otherwise." (11) The Rule requires individuals who take a casualty loss deduction and subsequently make a recovery for that loss to count that recovery in their income for the year in which they receive the recovery, potentially causing major financial hardship to individuals.
Part II identifies and analyzes the circuit split between the Courts of Appeal for the Eleventh and Ninth Circuits regarding whether application of section 165(c)(3) requires physical damage to the property, or whether general decline in property value suffices. Oil spills occupy a unique niche within the broader category of casualty losses because publicity surrounding oil spills contributes to a broad decline in property values, regardless of whether a property was directly damaged or contaminated by the spill. To allow for casualty loss recovery due to a general decline in value of surrounding properties, provisions must be put in place to allow for widespread recovery and to prevent inequitable outcomes due to the jurisdiction in which the taxpayer resides. By streamlining the framework for recovering from oil spills, the federal government could bypass the circuit split on general property value decline and adopt the Eleventh Circuit's position as announced in Finkbohner v. United States, (12) at least in the oil spill context.
Part III identifies three current approaches to compensating oil spill victims: the OPA, the Gulf Coast Claims Facility (GCCF), and private causes of action in tort and insurance. It identifies shortcomings in each of these avenues of recovery, focusing on the burdens and tradeoffs taxpayers face in the wake of casualty losses. It suggests that the current infrastructure for dealing with casualty losses is inefficient and results in unnecessary hardships for taxpayers and argues that there ought to be a more streamlined, uniform system of recovery for oil spill victims with casualty losses.
Part IV discusses the Stafford Act and Code section 165(i)(1), (13) which makes special provisions for individuals claiming casualty loss deductions when the President of the United States invokes the Stafford Act. This Part also discusses legislation Congress enacted to bolster the benefits of the Stafford Act in response to Hurricane Katrina, allowing for elimination of the floors and ceilings associated with casualty loss deductions. It explains when and how the Stafford Act is implemented in response to natural disasters and examines the political and social justifications for the allowances the Stafford Act provides for victims of natural disasters. Further, it analyzes legislative approaches that the federal government has taken in the past, in conjunction with an invocation of the Stafford Act, to adjust the floors of Code section 165(h) (14) to allow more widespread taxpayer recovery. It explains why President Obama did not invoke the Stafford Act in response to this disaster by offering a comparative analysis of the Presidential response to the Exxon Valdez oil spill off the coast of Alaska in 1989. An invocation of the Stafford Act would have been an inappropriate presidential response to the Deepwater Horizon incident, given the restrictions, mechanics, and justifications of the Stafford Act, particularly because this and other oil spills are almost always the result of human agency. But the direct and indirect damages suffered by victims in oil spills are so analogous to those suffered by the victims of natural disasters that, at the very least, the tax allowances extended by an invocation of the Stafford Act ought to be extended to the victims of oil spills.
Finally, Part V identifies a solution for the shortcomings of the current methods of recovery for individual taxpayers suffering property damage in this or future oil spills, drawing on an approach recommended by another scholar: (15) IRS subrogation and a removal of the Code section 165(h) floors. (16) Instead of taxpayers individually filling claims with the BP Oil Spill Fund, this Note proposes that the Code section 165(h) (17) floors be eliminated in the case of an oil spill, allowing everyone to deduct casualty losses to property. Then, the IRS can subrogate those claims and recover from the BP Oil Fund or other funds created by section 2715 of the OPA, (18) thereby avoiding lost tax revenue. This approach creates an equitable remedy for taxpayers, lowers transaction costs for all parties involved, and would be easy to implement, especially given the federal government's use of subrogation in other contexts.
CASUALTY LOSS DEDUCTIONS FOR INDIVIDUALS: THE ADMINISTRATIVE LIMITATIONS OF APPLYING I.R.C. [section] 165(c) TO THE VICTIMS OF OIL SPILLS.
Code section 165 provides as a general rule that "any loss sustained during the taxable year and not compensated for by insurance or otherwise" may be deducted as a loss, with limitations set by its subsections. (19) Section 165 has been called a "free partial insurance scheme." (20) Justifications for allowing a casualty loss deduction include ensuring that the income tax reflects a taxpayer's ability to pay and ensuring that the income tax equals consumption plus savings, since "amounts lost to casualties are neither consumed by the taxpayer ... nor saved." (21)
There is little legislative history about the meaning of "casualty" as contemplated in section 165(c), and its parameters "have evolved judicially." (22) Courts have interpreted casualty losses to individuals under section 165(c)(3) to require an element of suddenness, unusualness, unexpectedness, or some combination of the three. (23) Additionally, casualty losses are subject to two major statutory monetary limitations. First, under section 165(h)(1), each loss must exceed $100. (24) Second, under section 165(h)(2), a net casualty loss is allowed "only to the extent it exceeds 10 percent of adjusted gross income ('AGI')." (25) In some disaster situations, these floors and other statutory barriers to recovery from casualty losses are lifted, either under a specific provision of the Code (26) or by legislative mandate. (27) This provision of the Code has been called "free insurance," (28) and has been criticized for discouraging people from purchasing property...