Position yourself for growth in 2017—join us live at the Entrepreneur 360™.
Flash Sale—save up to $200 on registration. Ends Thursday. Secure Your Seat »
Due to the severe weather conditions caused by El NiÃ±o, many businesses suffered costly property and casualty losses in recent months. At press time, the number of federally declared disasters in 1998 had already reached 41--compared to 45 for all of 1997. This year is shaping up to be a serious one for disasters, says the Federal Emergency Management Agency's Marc Wolfson.
The government tracks the impact of disaster losses on businesses by the number of disaster loans it makes to business owners. In the first nine months of this fiscal year, the SBA's disaster assistance program approved more than 4,000 business loans, totaling almost $224 million.
If your business was unlucky enough to suffer a loss from a natural disaster, especially in a federally declared disaster area, take heart: You're probably eligible for some tax relief. If the president declares a specific location a federal disaster area, business owners can receive federal assistance, such as low-cost disaster loans and special tax benefits. While the deductions won't replace what a natural disaster or other mishap has taken away, the tax benefits may make your disaster-related problems a bit easier to endure.
Even if your business hasn't yet experienced a disaster, it's important to know what you're entitled to in case you're not so lucky next time around.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 12 years.
Does Your Disaster Qualify?
If you've suffered a financial loss due to a natural disaster, the IRS lets you deduct it on your tax return for the year in which the disaster took place or in the immediately preceding tax year if certain requirements are met. First, the loss must have taken place in an area the president declares in need of federal assistance. Second, the tax return for the preceding year must be amended by the date it's due or, if that date has already passed, by the tax return due date for the year of the disaster. Tax experts say the best way to determine which year to claim the disaster loss is to calculate for each of the years the tax effects of claiming the loss. Then select the one that is most beneficial to you.
Business owners should also be aware of a recent change in the Small Business Act of 1996 regarding losses caused by natural disasters. Under the act, business property damaged by a natural disaster is eligible for what's called "nonrecognition of gain." This means that qualified replacement property can be bought and the gain deferred.
"The law is designed to provide relief to businesses forced to suspend operations for a substantial time due to the property damage," says Mark Luscombe, principal federal tax analyst for CCH Inc., a Riverwoods, Illinois-based provider of tax and business law information. Often when a business needs to close temporarily, it loses customers and eventually folds.
As a result of the 1996 change, if a company loses customers during a suspension and goes out of business, the owner can reinvest capital from that business in an entirely new venture. This change is significant, says Luscombe, because in the past, a business owner had to reinvest in an identical business. Now he or she can start fresh with a different business. This provision applies retroactively to presidentially declared disasters made after December 31, 1994, in tax years ending after that date.
Defending Your Deductions
While you're able to take tax deductions for disaster losses, keep in mind that the IRS wants to see evidence that a loss actually occurred and that it was caused by a disaster.
What kind of documentation will support your claim with the IRS? You'll need details about the nature of the disaster, a written description of the damaged property and the date the damage occurred. You must also explain how the loss was the direct result of the disaster. It's a good idea to have photos of the area before and after the disaster as well as newspaper articles that explain the damage in your neighborhood.
You must also supply the IRS with proof, such as a deed or other ownership information, that shows you own the damaged property and are legally responsible for it. Another requirement is proving your tax basis in the property. The basis is the amount you paid for the property plus the cost of improvements, less depreciation. Also keep in mind that before you take your deduction, you must reduce the amount of your loss by any insurance proceeds you receive.
Be sure to show proof of the value of the property before and after the loss so you can show the amount of loss the property's value suffered. To fulfill this requirement, you may have to have an appraisal done. You'll want to get it in writing, usually in the form of an estimate.
If you repair or replace the damaged property, the IRS generally allows you to prove the value with receipts that show the cost of replacement or repairs. If your computer operation suffers losses, for example, be sure to keep track of the repair or reconstruction costs involved in getting your computers back up and running.
On a positive note, Congress also recently changed the rules regarding appraisals required to establish a disaster loss. The IRS may now accept an appraisal used to secure a loan or a loan guarantee from the federal government to establish the disaster loss for tax purposes, says Luscombe. This change makes it easier to establish the value of your property both before and after the damage, he says.
Remember, if your casualty loss deduction is more than your income for the year, you may have a net operating loss. You can use that loss to lower your taxes for an earlier year, allowing you to get a refund for taxes you already paid. The IRS will also allow you to lower your tax bill in a later year.
Effective for losses taking place this year or later, Congress changed the carry-back period for most net operating losses from three years to two years and the carry-forward period from 15 years to 20 years. But the carry-back period for net operating losses caused by damage to the physical premises or theft remains three years.
While no one ever expects to suffer a business loss due to a natural disaster, if the unthinkable happens, don't get caught not knowing what you're entitled to, especially when it comes to tax deductions.
The Politics Of Taxes
Congress debates abolishing the tax code.
As congress ready to retire the existing tax code? While some lawmakers are more than ready to do so, don't expect such a sweeping change any time soon.
The recent passage of House bill H.R. 3097, which would abolish the current tax code by January 1, 2002, is seen by many Capitol Hill observers as a purely symbolic act designed to put tax reform front and center during the next presidential election. Along with reforming the IRS, simplifying the existing tax code is a popular issue with voters, especially business owners. It's also one that Republicans intend to make a major campaign theme.
The measure, which passed by a vote of 219 to 209, was sponsored by Rep. Steve Largent (R-OK). While it has the support of some lawmakers, a number of moderate Republicans joined Democrats in opposing the measure. Although the bill directs Congress to enact a new tax system by July 4, 2002, it doesn't specify which new tax system Congress should adopt.
There's the rub, say critics. "It's important to come up with a viable alternative with some safeguards so that [tax] revenues won't plummet," says Thomas P. Ochsenschlager, a partner in the Office of Federal Tax Services of accounting firm Grant Thornton LLP in Washington, DC. Even Sen. William V. Roth Jr. (R-DE), chairman of the Senate Committee on Finance and a sponsor of the IRS reform bill, questioned the legislation, saying he had serious concerns about retiring the current tax code without an alternative in place.
The bill faces considerable opposition in the Senate as well as from the White House. Says Ochsenschlager: "Clinton would never sign such a bill, and if he vetoes it, Congress would not have enough votes to override."
As congressional and presidential campaigns begin to heat up, however, expect to hear from the candidates of both parties about how to best reform the current tax code.
For more details on claiming disaster losses, order a free copy of IRS publication #547, Casualties, Disasters and Thefts. Call (800) TAX-FORM.
Grant Thornton LLP, 1707 L St. N.W., #230, Washington, DC 20036, http://www.gt.com