BP's $20 Billion Fund Is Subject to Taxes

Average Americans put out of work by the BP oil spill will have to pay taxes on money received from the disaster-relief fund.
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BOSTON (TheStreet) -- BP's (BP) - Get Report $20 billion fund to pay for disaster-related compensation may enrich the government more than the oil-industry roughnecks, local shrimpers and other workers put out of a job because of the Gulf of Mexico oil spill that began three months ago tomorrow.

Unless Congress passes a new law, most of those who receive relief from the fund will have to pay taxes to the U.S. Internal Revenue Service, potentially making the government the biggest single beneficiary of money set aside to help average Americans. The Obama administration urged the energy company to create the fund.

On Friday, BP announced that it has so far paid out $201 million to more than 32,000 claimants. The largest groups include fishermen, who have received $32 million, and shrimpers, who have gotten $18 million. In addition, about $77 million has been paid for loss of income to a variety of occupations including deckhands and employees of seafood-processing plants and other businesses in the economically devastated region.

Although reimbursements for personal-injury settlements would be non-taxable,

the IRS recently clarified

that payments for lost wages will be taxed, just as business income would be.

In response to the IRS policy, Congressman Charlie Melancon (D-LA) has introduced legislation that would shield the payments from taxes. His Oil Spill Tax Relief Act of 2010 is modeled after a law that exempted payments from the 9/11 Victims Compensation Fund from income taxes.

"With the oil spill hurting Louisiana's three major economic sectors -- seafood, offshore energy production, and tourism -- thousands of people are struggling to pay their bills and get by day to day," Melancon said in a statement. "Compensation from BP will help, but during this uncertain time Louisianans will need to stretch every dollar and should not have to worry about setting aside a portion of the payments for taxes."

"It comes as no surprise that the IRS -- the most aggressive collection agency on the planet -- wants its cut from disaster victims struggling to stay afloat who need the BP checks to pay bills and buy much-needed supplies and groceries," says Brian Compton, president of Los Angeles-based Tax Resolution Services, a tax negotiation and mediation firm.

Melancon is also urging BP to fund mental-health services for residents experiencing depression and anxiety following the disaster.

Louisiana's Department of Health and Hospitals advised the U.S. Department of Health and Human Services in a July 9 letter that the state has written twice to BP, most recently on June 28, asking for $10 million for such services without receiving a reply.

Even some of that fought-for funding could fall into the hands of the taxman. Under IRS code, direct compensation for emotional distress is taxable. Only related medical costs can be deducted.

Compton advises any victim of the spill receiving lost-wage compensation to be aware that payouts from the fund effectively make them self-employed. Even if their regular employer took care of their paycheck deductions and issued a W-2 form, receiving money from BP now puts them in the position of taking care of those payments themselves. To avoid penalties and fees, they should make sure to arrange for quarterly tax payments, just as any freelancer or independent contractor would.

He also advises that residents of the Gulf should seek out professional guidance to make sure they are on top of any disaster-related tax strategies that may apply. Because the after-effects of the spill will likely drag on for years, a comprehensive tax strategy is crucial

Those receiving lost-wage compensation may have one tax break, at least.

A payment to an individual to compensate for lost wages will not be subject to Social Security and Medicare taxes "because it is not an actual payment for employment within the meaning of the law," the IRS advises.

-- Reported by Joe Mont in Boston.

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