South Carolina Catastrophe Savings Accounts have a tax loophole residents should learn about
I have some interesting news for South Carolina residents about a tax loophole that could come in handy if the 2013 Atlantic hurricane season turns out to be a rough one.
Hopefully, none of us will need to use this little-known state tax break, but it's good to be aware of the options.
I've written before about Catastrophe Savings Accounts, which are a tax-advantaged way to set aside money to cover things such as disaster-related home insurance deductibles. Well, it turns out those accounts have a bit of a loophole, much like the one I've written about with South Carolina's 529 college savings plan.
Simply put, there's nothing in the law that says you can't open a Catastrophe Savings Account after there's already been a disaster. You can put money in the account you create, take the money back out to pay qualifying disaster expenses and still deduct the money from your taxable South Carolina income.
That's not quite the intent behind those accounts, but that's what the law allows; the lawyers at the S.C. Department of Insurance agree with me on this.
My personal philosophy has always been that people shouldn't cheat on their taxes or engage in questionable tax-avoidance measures. But people should know the tax rules and make use of tax reductions that are clearly allowed, such as this one.
The Catastrophe Savings Account loophole is very similar to the one in South Carolina's Future Scholar 529 college savings plan.
In both cases, the savings accounts offer state tax deductions on contributions and tax-free earnings in order to encourage people to save for large expenses: higher education with a 529 plan, disaster-related expenses with a Catastrophe account.
And in both cases, money can be deposited at any time, used right away for qualifying expenses and still count as a state income tax deduction. For most people with South Carolina tax liability, that's like getting 7 percent back.
There are rules to follow, of course, but if you were suddenly hit with having to write a great big check to cover a hurricane (wind and hail) insurance deductible, wouldn't it be nice to save up to $1,050? That's the maximum that homeowners with insurance can save on their S.C. tax bill by deducting contributions to a Catastrophe Savings Account (the maximum contribution of $15,000 multiplied by 7 percent).
One challenge is that Catastrophe Savings Accounts have not seen much consumer demand, and, as a result, few banks and credit unions specifically offer them. However, the only requirement for such an account is that it must be a savings account set up with a federally chartered institution, designated as a Catastrophe Savings Account, and used only for that purpose.
I think people haven't rushed to set up those accounts because the rules require keeping funds in a savings account, and these days such accounts pay virtually no interest. Of course, if you don't fund the account until there's already been a disaster and you need the money, then interest doesn't matter.
So consider finding an institution that will let you open a Catastrophe Savings Account with a small deposit and no monthly fees. Or at least figure out where you would go to open one of those accounts if you wanted one. Then, if disaster strikes, you'll be ready to take advantage.
Here are the basic rules.
Accounts can be opened by people who own their legal residence in South Carolina.
Contribution limits depend on insurance deductibles. If the deductible is more than $1,000, you can contribute up to twice the amount, not to exceed $15,000.
The contributed money is deductible from South Carolina taxable income. There's no federal deduction.
Qualifying expenses are those “paid or incurred by reason of a major disaster that has been declared by the governor to be an emergency by executive order.” They include insurance deductibles and other uninsured risks of loss from hurricanes, flood-waters, or wind damage.
The funds must be held in a savings account.
If you put money in an account then use it for nonqualifying expenses, you could face a penalty and have to repay what you saved from the tax deduction by declaring the funds as income.
At age 70, you can withdraw Catastrophe Savings Account funds with no penalty, and you don't have to declare the money as income. In other words, someone that age who otherwise qualifies can put money in one of those accounts, claim the tax break, then take the money out and close the account. Once you close such an account, further contributions are prohibited.
Different rules apply for those who are self-insured.
Catastrophe Savings Accounts offer a tax break that we hopefully will never need. People who have large deductibles and South Carolina income tax liability are in the best position to find such accounts beneficial.
Reach David Slade at 937-5552 or Twitter @DSladeNews.