SSR 74-17: SECTION 211(a)(3)(C) (42 U.S.C. 411(a)(3)(C)). -- NET EARNINGS FROM SELF-EMPLOYMENT -- DISASTER LOSSES TO INVENTORY

20 CFR 404.1055(b) and (c)

SSR 74-17

Where a self-employed retirement insurance beneficiary sought to deduct on his 1971 Federal income tax return a casualty loss to his inventory in 1972 that was occasioned by tropical storm "Agnes" in an area determined by the President of the United States to warrant assistance under the Disaster Relief Act of 1970, it is held that a casualty loss to inventory is not deductible for the 1971 taxable year in computing net earnings from self-employment but is automatically reflected in cost of goods sold.

R, a retirement insurance beneficiary, was overpaid benefits for 1970 and 1971 due to excess net earnings from self-employment. R filed an amended tax return for 1971, electing to take the loss resulting from tropical storm "Agnes" against his 1971 income, thereby apparently reducing his self-employment income and net earnings, from self-employment income to zero.

The issue is whether a self-employed individual may deduct on the preceding year's tax return a loss to his inventory resulting from a casualty in an area determined by the President of the United States to warrant assistance under the Disaster Relief Act of 1970. If so permitted and the allowance of the casualty loss in 1971 results in a net operating loss, such net operating loss may be carried back to 1968, 1969, and 1970, in that order.

As indicated by section 211(a)(3)(C) of the Social Security Act, gains or losses (including disaster losses) from property not held for sale in the ordinary course of business are not taken into account in computing net earnings from self-employment, even though such gains or losses may be subject to the Federal income tax provisions. However, since inventory affects such computation, reference must be made to the Internal Revenue Code of 1954 for interpretation of the tax provisions.

Section 165(a) of the Internal Revenue Code of 1954 provides for the allowance of a deduction for any losses sustained during the taxable year which are not compensated for by insurance or otherwise. In the case of an individual, section 165(c) of the Code limits the deduction provided for in section 165(a) of the Code to losses incurred in a trade or business; losses incurred in any transaction entered into for profit, though not connected with a trade or business; and losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. Losses of property not connected with a trade or business and resulting from a casualty or theft are allowed only to the extent that the amount of loss to the individual arising from each casualty, or from each theft, exceeds $100.

Public Law 92-418 amended section 165(h) of the Internal Revenue Code of 1954 effective for disasters occurring after December 31, 1971, in taxable years ending after that date. Section 165(h) of the Code provides that, notwithstanding the provisions of section 165(a) of the Code, any loss attributable to a disaster occurring in an area subsequently determined by the President of the United States to warrant assistance by the Federal Government under the Disaster Relief Act of 1970 may, at the election of the taxpayer, be deducted for the taxable year immediately preceding the taxable year in which the disaster occurred.

However, section 1.165-11(b)(3) of the Income Tax Regulations provides that the election provided by section 165(h) of the Code applies only to a loss arising from fire, storm, shipwreck, or other casualty, and otherwise allowable as a deduction for the year in which the loss occurred under section 165(a) of the Code and those provisions of sections 1.165-1 through 1.165-10 of the regulations which are applicable to casualty losses.

Section 1.165-7(a)(4) of the regulations provides that section 165 of the Code does not apply to a casualty loss reflected in the inventories of the taxpayer. For provisions relating to inventories, that section of the regulations refers to section 471 of the Code and the regulations thereunder.

Section 1.471-2(c) of the regulations provides, in part, that any goods in an inventory which are unsalable at normal prices or unusable in the normal way because of damage, imperfections, or other similar causes, should be valued at bona fide selling prices less direct cost of disposition.

Accordingly, it is held that since R's casualty loss to inventory is not a deductible loss under section 165 of the Code, he may not elect under section 165(h) of the Code, to deduct this loss on his Federal income tax return for the preceding year. The loss, instead, is automatically reflected in the cost of goods sold under the provisions of section 1.471-2(c) of the regulations and in that way is taken into consideration in the computation of net earnings from self-employment.


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