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Corporate Tax Options Available for Casualty Losses on Underinsured or Uninsured Business Property

Posted at Mar 01, 2016

The importance of proper documentation from a public adjuster

By Michael C. Perlmuter, JD, President & General Counsel

and Donald J. Dragony, CPA, CFF, Senior Vice President, Chief Financial Officer & Director of Forensic Accounting

Alex N. Sill Company typically represents insured business policyholders in connection with adjusting property claims from insured perils such as a fire, hurricane, tornado and other calamities. In most cases, our business clients, fortunately, have sufficient insurance to cover the damages. However, there are instances where a business owner is either not insured or is underinsured vis a vis the damages sustained.

So, the question is commonly asked of us: Does an uninsured or underinsured business owner have any tax relief options? 

Fortunately, the answer is Yes!

Businesses having experienced a property / casualty loss and preparing to file their annual corporate federal and state returns may have several additional options for improving their tax position — and potentially gain the benefit even quicker — but only if they have completed the proper documentation contemporaneously with the loss.

Corporate tax returns potentially provide a measure of recovery for businesses suffering a property / and casualty loss not fully covered by insurance. Businesses must include the non-covered portion of the loss on its return which is taken as a debit against the gross revenue.

As exists with all return entries, the Internal Revenue Service specifies the methods and means businesses must use to report the property / casualty event. Within are decisions business owners and managers can make along with their accounting and tax professionals to best take advantage of the situation.

Step 1: Determine the remuneration amount

The first step is determining the remuneration amount either already expected or received from the insurance payout. That amount, subtracted from the lesser of:

  1. the adjusted cost basis of the property involved, or
  2. the decrease in fair market value renders the remaining non-covered portion of the loss.

Thus, a partially destroyed property with an adjusted basis of $1 million and decrease in fair market value of $1.2 million, for which $750,000 in insurance proceeds is either received or expected A) results in a $250,000 loss, and B) the business is “potentially” entitled to a $250,000 net operating loss (NOL) deduction. That is calculated by taking the adjusted basis ($1MM), which is less than the decrease in market value ($1.2MM), and subtracting the insurance payments ($750k).

Step 2: Documenting the proof

Sounds easy so far, but the second step — documented proof –– is required by the IRS in order to successfully claim such a deduction. An uninsured or under-insured property owner will need to hire an organization such as ours to substantiate the attempted tax loss. The IRS is likely to disallow the entered amount if it is not properly documented.

This is where many business owners run into issues when attempting to take a tax casualty loss on tax returns. Too often, business owners, hoping to take such a deduction, wait until tax preparation season to explore this option with the accountant. By then, it will likely be too late to utilize this tax strategy. In order to prevail with the IRS, the business owner needs to have a detailed damage estimate prepared by a professional public adjuster such Sill contemporaneously with the loss.

Once a fully documented loss estimate from the public adjuster is completed, the business owner can head to the next step.

Step 3: When to take the loss amount to Net Operating Loss

Step three is determining when to take the loss amount towards the NOL, which a business can generally carry-back two years and then carry-forward 20 years from normal operations.

IRS regulations allow businesses the option of reporting the loss in the year in which it occurred OR reporting it in the previous year. Businesses need to consider the strategic implications.

Simply reporting the loss in the current year may render little immediate value if a business already had losses for the year that exceeded its income. However, a business can report the applicable NOL in the previous year (should it be deemed of value) by submitting amended federal and state returns.

A couple of other points here:

  • Small businesses (those with less than $5 million annual revenue) or entities engaged in farming, may elect a special three-year carry-back if the NOL resulted from fire, storm or theft in a federally declared disaster area.
  • A property / casualty event which resulted in a loss of business inventory can be categorized as just that, a casualty loss, OR it may be treated as a cost of goods sold. Classification as the latter likely will decrease the businesses’ net income and could possibly save taxpayers some Self-Employment Contributions Act (SECA) tax.

As public insurance claims adjusters, the Sill Company has been entrusted, for over 85 years, with exclusively representing policyholders in connection with the claims against their insurance carriers, from the catastrophic event to final settlement. We also know that every situation differs, having its own set of parameters and nuances. In that regard, the preceding information is provided only as a general guideline.

You are advised to consult with your professional accounting, tax and legal advisors about your company’s specific situation and respond accordingly.

One last step for now. Resist the temptation to boost the NOL by heaping the discovery of newly found additional items that should have been part of the initial loss on top of the non-covered portion. The insurer has closed that case. The finding of potential additional damage must be handled as a new, separate claim. This doesn’t impact the filing of the current loss on returns, but may contribute to a future recovery and NOL.



Written by Sillco