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Handling Losses

Handling Disaster Losses from a Tax and Financial Perspective

Handling LossesSeptember 2021 saw unprecedented destruction due to wildfires in California as well as Hurricane Ida—which cut a path of tornados and flooding up through more than a dozen states. But disasters can happen at any time in any location. If a business has been impacted by a disaster, hopefully there is insurance to cover the loss. But in reality, insurance may not cover everything…especially if you have a high deductible on the policy. What can you do from a tax and financial perspective to “weather the storm?”

Submitting insurance claims

Hopefully, you have your insurance company or agent’s telephone number in your contact list so you can immediately begin the claims process. Here are some steps to take:

  • Contact the appropriate party as soon as you can. You can then be assigned a claims number to be used throughout the claims process. Some policies require that claims be submitted within a set period, so don’t fail to act promptly.
  • Take inventory of your business property. What’s been destroyed? What’s been damaged? What’s been stolen (unfortunately looters may become active in the wake of a disaster)?
  • Document your losses. You may want to make temporary repairs if possible, but be sure to have photos of the initial condition of repaired items.
  • Meet with your insurance adjuster. Be prepared to negotiate the amount that the insurance company wants to pay you. It may be necessary to bring in an attorney to receive optimum compensation (but, of course, the attorney will cost you money too).

If you have business continuation coverage or business interruption coverage, be prepared to submit financial information. Today, with most business information stored in the cloud, it may be easy to provide what’s necessary even if business computers and papers are destroyed in the disaster.

You can learn more about submitting an insurance claim from the Insurance Information Institute (iii).

Writing off disaster losses

Taxwise, to the extent that insurance or other payments (e.g., government grants) do not make you whole, you can take a tax loss. To do so, you need to:

  • Submit an insurance claim if you have coverage. Failing to do so (perhaps you think you’ll be dropped by the insurance company or have premiums raised) bars any tax write-off.
  • Determine the extent of your tax loss. This is the adjusted basis in the property (usually the cost of the property minus depreciation claimed), reduced by any salvage value and any insurance or other reimbursements received or expected to be received. (Unlike losses to personal-use property, there are no other reductions to the allowance tax loss.) There are 2 ways to handle inventory losses: (1) increase in the cost of goods sold by properly reporting the opening and closing inventories and include any insurance or other reimbursement received for the loss in gross income, or (2) deduct the loss separately and eliminate the affected inventory items from the cost of goods sold by making a downward adjustment to opening inventory or purchases.
  • Decide when to claim the loss. You can take the loss in the year you suffered the disaster. Or you may opt to deduct the loss on the tax return for the prior year. If you have not yet filed the return for the previous year (e.g., you are on extension for your 2020 return and had damage from Hurricane Ida so that you have until January 3, 2022, to file last year’s return), simply take the loss on the prior year return. If you already filed the prior year return, then file an amended return to take the disaster loss.

You can learn more about tax losses in IRS Publication 584-B, Business Casualty, Disaster, and Theft Loss Workbook and IRS Publication 2194, Disaster Resource guide for Individuals and Businesses.

Note: If the insurance proceeds you receive are more than your tax basis, you have a tax gain (called an involuntary conversion). For example, if you have $1 million in equipment that’s destroyed in a disaster, the cost of which has been fully deducted, an insurance payment of $600,000 (what the insurance company pegs as the property’s value), you have a $600,000 tax gain. However, you may defer paying tax on this gain by investing the proceeds in replacement property within a set time. For more information about involuntary conversions, see IRS Publication 544, Sales and Other Dispositions of Assets.

Obtaining an SBA disaster loss loan

If insurance and other programs don’t make you whole or you just need additional financial help, you may qualify for assistance through the SBA. There are two low-interest disaster loan programs:

  • Business Physical Disaster Loans. These are loans up to $2 million that may be used to repair or replace real property, machinery and equipment, inventory, and leasehold improvements.
  • Economic Injury Disaster Loans. These are loans up to $2 million to help meet financial obligations and operating expenses that could have been met had the disaster not occurred. The loan amount is based on actual economic injury, regardless of whether there was any property damage. Note: This EIDL is different from the COVID-19 EIDL.

Note: Having a D-U-N-S number from Dun & Bradstreet may help expedite an SBA disaster loan. If you don’t have such a number, obtain one now; it’s free.

Final thought

Sylvia Matthews Burwell, director of Office of Management and Budget under President Obama and current president of American University, said: “While natural disasters capture headlines and national attention short-term, the work of recovery and rebuilding is long-term.”

Good luck to businesses that suffer through a disaster and have the will to rebuild.