Individual taxpayers who suffered losses to their homes and personal belongings during the 2017 hurricane season should be aware that the IRS introduced safe harbor methods to calculate those losses on their 2017 income tax returns that they will file in April of this year.
Under the IRS guidance issued in December 2017, taxpayers with casualty losses of $20,000 or less may use an Estimated Repair Cost Method by using the lesser of two repair estimates prepared by two separate, independent and licensed contractors to determine a property’s decrease in fair market value (FMV). The estimates must detail the itemized costs required to restore the property to the same condition it was in immediately before the casualty event. Any improvement costs that would increase the property’s value above its pre-casualty condition must be excluded from the calculation.
For casualty losses to personal-use residential real property and personal belongings of $5,000 or less, taxpayers may rely on a De Minimis Safe Harbor Method under which they may use a good faith estimate of the cost of repairs required to restore the real property to its pre-casualty condition and the decrease in the fair market value of the individual’s personal belongings. Under this method, taxpayers must maintain meticulous records describing the affected real and personal property and detailing the methodology used for estimating the loss.
The Insurance Safe Harbor Method allows taxpayers to rely on reports from their homeowners’ or flood insurance companies that estimate the amount of losses they sustained to personal-use residential real property.
In addition to these safe harbor methods, individuals who suffered casualty losses to personal-use residential property as a result of a federally declared disaster may use the following methods: (1) the Contractor Safe Harbor Method under which the taxpayers may rely on contract price for the repairs specified in a binding contract prepared by a licensed independent contractor and signed by the individual and the contractor, or (2) the Disaster Loan Appraisal Safe Harbor Method, which allows taxpayers to use the estimated loss contained in appraisals prepared for the purpose of obtaining a Federal loan or loan guarantee from the Federal Government. To determine the amount of casualty or theft losses for personal belongings located in a federally declared disaster area, individuals may also use a Replacement Cost Safe Harbor Method that relies on a table that values the property based upon such factors as the amount of time the individual owned the property prior to the casualty event.
In a separate IRS announcement, the agency detailed safe harbor methods to specifically help victims of Hurricanes Harvey, Irma and Maria determine the amount of losses these storms inflicted on their homes located in Texas, Louisiana, Florida, Georgia, South Carolina, Puerto Rico, and the U.S. Virgin Islands. The calculations are based on cost indexes that consider the size of a home as well as the location and extent of its damages.
It is important to note that the IRS issued this updated guidance in December 2017, just prior to the passage of Tax Cuts and Jobs Act, which overhauls the tax code beginning on Jan. 1, 2018. The new law limits the tax break for personal casualty losses to those damages that result from a disaster declared by the president of the United States. On the surface, it appears that victims of major disasters, such as hurricanes and other federally declared disasters, would still be allowed to deduct personal casualty losses in the future, while homeowners affected by fires, flooding, winter storms and other casualty and theft events may no longer benefit from this form of tax relief. However, the actual implications of the new law will not be fully known until later this year when the IRS issues technical guidance on how it will address the provisions of the new tax law.
With offices in South Florida, Berkowitz Pollack Brant is well aware of the complicated tax and insurance issues individuals and businesses face when preparing for and recovering from natural disasters, such as hurricanes. Our advisors and accountants work closely with clients to insure and support claims of business interruption and assess of damages to property and businesses for purposes of claiming casualty loss tax deductions.
About the Author: Arkadiy (Eric) Green, CPA, is a director of Tax Services with Berkowitz Pollack Brant, where he works with real estate companies, commercial and residential developers, property management companies, real estate investors and high-net-worth individuals to structure investments and complex transactions for maximum tax efficiency. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.
With hurricane season upon us, businesses in South Florida and all along the east coast should have an emergency plan in place to safeguard their organizations before and after a disaster occurs.
What types of situations can impede normal business operations? How can a business protect itself from these events, which may include power outages, burst water pipes, server failures, data hacks, fires, floods or acts of nature? How can a business mitigate its losses following a disastrous event? What does the business need to do to recover in a timely manner, if recovery is even possible?
Answering these questions in advance of a potential threat can help businesses be better prepared to act quickly and reduce their risks of interruptions in normal business operations. Following are a few critical factors businesses should consider when preparing a business continuity and disaster-recovery plan.
Employees. How will a business communicate with its workers and their family members during and after a disastrous event? Which business functions and staff members will be required during the preparation and recovery periods?
Businesses should maintain up-to-date contact information for all of their employees and put into place a system for sharing information with them. In the wake of recent disasters involving power outages and overloaded telephone networks, text messaging has proven to be an effective communication tool. In addition, businesses should ensure that critical employees know their roles and responsibilities to carry out the business’s emergency plan. Similarly, the business should be prepared to assign backup staff to cover for those workers who may be unreachable or unable to return to work following a perilous event.
Customers. Businesses that cannot respond to customers’ immediate needs are likely to lose those customers. To build trust and loyalty, businesses should communicate their emergency plans to customers before disasters strike and have in place a plan for communicating with them and providing them with alternative arrangements in the wake of a disaster.
Suppliers and Vendors. Interruptions in the supply chain can cripple a business when its vendors or suppliers are unable to deliver required services, products and materials. As a result, businesses should first consider whether or not their existing suppliers have business-continuity plans in place and whether such plans should be a requirement of their working relationships. In addition, businesses should have at the ready a backup list of pre-vetted suppliers who can step in to fulfill their orders in a timely manner.
Critical Business Functions. What activities are vital to a business’s survival? Critical business functions include those assets that are required to resume operations and those activities whose interruption will result in a loss of revenue and noncompliance with industry and governmental regulations. Businesses must prepare contingency plans in the event a disaster debilitates these functions.
Documents and Data. All businesses should have backup systems in place to retrieve and restore data in order to resume normal operations. This may include keeping duplicates of important records off-site, downloading them onto portable storage devices, such as external hard drives, or saving them to cloud-based applications. Similarly, businesses should regularly update their accounting and operational data, including records of inventory and sales as well as forecasts of future performance, in order to quantify and substantiate incurred losses.
Insurance. Property insurance typically covers costs to repair physical damage. Companies located in regions that are prone to hurricanes, earthquakes, tornadoes or floods should also consider investing in business-interruption insurance to cover the potential loss in income due to an inability to continue normal operations in the aftermath of a covered catastrophe. In fact, in today’s environment of frequent cyberattacks and data breaches, weather conditions and natural disasters are far from the only factors that can impede business operations and lead to monetary and reputational losses. Business interruption insurance helps organizations mitigate these losses and quantify and substantiate claims of lost earnings.
The professionals with Berkowitz Pollack Brant’s Forensic Accounting and Business Insurance Claims practice have more than three decades of experience helping organizations of all sizes and in all industries prepare for and maximize financial recovery from insured perils.
About the Author: Daniel S. Hughes, CPA/CFF, CGMA, is a director in Berkowitz Pollack Brant’s Forensics and Business Valuation Services practice, where he helps companies of all sizes assess economic damages, lost profits and the quantification of business interruption insurance claims. He can be reached in the CPA firm’s Miami office at (305) 379-7000 or via e-mail at email@example.com.
Financial experts are often utilized by attorneys in commercial litigation cases. The goal is to make the injured party whole; in other words, to return the plaintiff to the financial condition the business would have been in but for the alleged acts of the defendant. Economic damage claims can be calculated by analyzing the affected business from two different perspectives – lost profits or lost business value, depending on the facts and circumstances of each case. The decision of which approach is appropriate should be decided by the damages expert and counsel early in the case, being aware that a business cannot typically recover both lost business value and lost profits.
The amount of damages under both approaches could be similar if all else is held constant. However, in reality, the damages may be significantly different due to the inherent differences in both approaches, which are discussed below.
On June 6, 2014, the Florida Supreme Court approved jury instructions for contract and business litigation that concisely presents the concepts of contract damages. Instruction 504.3, Lost Profits, explains that to recover lost profits, a claimant must prove the defendant caused the claimant’s lost profits and the amount of lost profits must be established “with reasonable certainty.” Instruction 504.4, Damages for Complete Destruction of Business, is only given in the case of a “complete destruction” of the claimant’s business. The jury is instructed that the claimant’s damages are based on the market value of the business; anything less than “complete destruction” would be compensated via the “lost profits” instruction. (Source: In re Standard Jury Instructions – Contract and Business Cases, Instruction 504.3-504.4, 116 So. 3d 284 (Fla. 2013)).
In many valuations (under the fair market value standard), the parties are the hypothetical willing buyer and willing seller as discussed in IRS Revenue Ruling 59-60; in lost profits analyses, the parties are not considered to be either hypothetical or willing. Another of the differences between a compliance-related valuation (i.e., those for tax and financial reporting purposes) and a valuation related to economic damages is that the business value in a compliance-related valuation is as of one specific date in time, whereas in a damage claim for diminution in business value, the value of the business is determined both before and after the causative act as of the dates decided by the court.
In a loss of business value calculation, only the facts known or knowable as of the valuation date are generally considered. The courts in some cases have allowed hindsight, even where there has been a loss of business value, such as when, if hindsight were not allowed, it would result in either a windfall gain or an unfair penalization of the plaintiff.
An early case, frequently cited even today, allowed hindsight and is referred to as the “Book of Wisdom” based on a 1933 U.S. Supreme Court decision in the case of Sinclair Refining Co. v. Jenkins Petroleum Process Co., 289 US 689 (1933). The decision in this case advocated the use of actual results to determine what the value of a patent should have been on the valuation date by proving the “elements of value that were there from the beginning”. The decision in Sinclair Refining effectively allowed for a valuation based on actual results after the valuation date that would supplant market value (based on forecasted data) estimated as of the valuation date since that assessment failed to accurately determine value for the undeveloped patent.
However, in a lost profits calculation, facts and events occurring after the alleged harmful actions of the defendant are considered. If the business lost earnings for a finite period of time, damages can be determined by using a lost profits approach and then adjusted for any mitigation of those damages by the plaintiff.
In the analysis of lost business value under an income approach, the discount rate utilized would typically be either the injured entity’s equity rate of return or its weighted average cost of capital (WACC), calculated using either a build-up method or the capital asset pricing model (CAPM). However, the discount rate utilized in a lost profits calculation could be one of those or others such as the plaintiff’s cost of debt, or its internal rate of return. Another option allowed by some courts is that the projected cash flows can be adjusted to account for the risk associated with them and a risk-free (or risk reduced) rate can be used.
Lost business value calculations consider all costs needed to generate the entity’s revenues and profits as compared to lost profits analyses, which typically place greater emphasis on costs associated with the lost revenues.
As is evident from the discussion above, the calculation of damages under either the lost profits approach or the loss of business value approach is complex and dependent on the facts and circumstances unique to each case, making it very important to utilize experienced, credentialed damage experts that will provide optimum assistance to counsel.
About the Author: Sharon Foote, ASA, CFE, is a member of Berkowitz Pollack Brant’s Forensic and Business Valuation Services practice. She can be reached in the firm’s Miami office at 305-379-7000 or by email at firstname.lastname@example.org.
As Hurricane Matthew churned along South Florida’s coastline, residents and businesses dodged a potentially devastating bullet. Yet, the storm serves as an important reminder about how businesses must prepare for and respond to natural disasters in order to minimize losses and ensure their long-term viability. The actions a business takes during the first few days following a loss can often determine the success of its recovery and settlement of insurance claims for property damages and lost profits.
Following are six tasks that well-prepared businesses incorporate in their continuity plans. If such a plan does not already exist, a business should still consider adopting these best practices to make the recovery process smoother and improve their chances of a complete and satisfactory recovery.
Step 1: Assess Damages. As soon as the danger has passed, business owners should conduct the following activities:
- Identify the cause and origin of the loss
- Assess structural components of the remaining facilities
- Determine the scope of physical damage
- Reach a consensus with an insurance representative on the scope of the damages
- Conduct a count of damaged and/or destroyed inventory
It is recommend that business owners record the damages they incurred via videotape as soon as possible after incurring a loss. A narrated video provides an inexpensive ounce of prevention if there are future disputes with insurers about specific damage.
Step 2: Protect and Secure the Site. Boarding up broken windows, making temporary roof repairs, covering machinery to protect against the elements and disconnecting utility services are examples of activities businesses should engage in to protect their property from further damage. In addition, consideration should be given to securing the damaged area with temporary fencing or security personnel to ensure it remains intact for subsequent investigation and calculation of losses. Retail establishments should take extra care to avoid looting. Securing the site and protecting property is typically an insurance policy requirement. Plus, it will help to expedite the business’s return to its normal operations.
Step 3: Form a Recovery Task Force. Business owners looking to get their operations up and running quickly must act fast to reestablish revenue streams from customers. The best way to accomplish this is to have a solid recovery plan carried out by a company task force made up the following key constituents:
- Employees representing the business’s damaged operations, such as an operations manager, head of manufacturing, etc.
- Personnel responsible for rebuilding, such as a facilities manager, project manager, etc.
- A representative with the construction contractor
- A risk manager or other staff member in charge of corporate insurance policies
- Key staff members who interact regularly with customers, such as sales directors or customer relations representatives
- A corporate finance or accounting liaison, who will serve as the gatekeeper to gather, track, and record the repair costs as well as distribute the necessary information to other appropriate parties
- Other consultants retained to assist in the recovery, including engineers, reconstruction experts and outside accountants and consultants
Step 4: Be Involved in Estimations of Losses. When an insured business has a covered loss, the insurance carrier will typically send out one of its adjuster to establish a “reserve”, which is an initial estimate of the loss. Rather than leaving this initial loss estimation solely in the hands of insurance adjusters or other outside consultants, business owners should involve themselves in the process. No one knows a business better than its owner(s), who have unique knowledge about the business’s operations and facilities as well as the cost of replacement equipment, building materials or temporary locations. Moreover, a business interruption estimate prepared in cooperation with a business owner is less likely to overlook important factors that might affect the ultimate amount of covered losses, such as recently awarded contracts, new customers, new products, recently implemented or soon to be implemented cost savings or efficiencies, which may affect the ultimate amount of the loss.
Step 5: Establish a Loss Accounting System. There are many ways for businesses to account for a loss, but the best method is to use a simple system that follows their normal day-to-day activities. Examples can include creating a set of charge codes related to the loss, establishing separate costs centers for each repair expense category or creating a project work order, as if the repair was a normal project. The goals should be to separate repair costs from normal operating expenses and keep them organized and easy to access.
Step 6: Run Expenses and Invoices through a Corporate Gatekeeper. Invoices for loss-related expenses should be routed to an individual in the business’s accounting department (e.g.; controller, chief accountant, etc.), who can review them for accuracy, appropriate detail and relevance to a claimed loss. The job of the Gatekeeper is to ensure that all invoices meet an insurance company’s reimbursement requirements before a business pays an invoice. If further detail is required from the vendor, it is often much easier to get the information before the invoice is paid rather than after.
Step 7: Get Help. The recovery from a loss is a traumatic and potentially significant event. For some companies, major losses threaten their very existence and a full recovery determines survival or extinction. Getting help from a professional accountant, lawyer and/or engineer who specialize in financial recovery from losses and keeps your best interests in mind can make the process less complicated. They will work with your company, insurance broker and the insurer’s representatives in the time consuming task of preparing complete and fully documented claims, allowing your personnel to concentrate on the task of serving customers, repairing facilities and returning to normal operations. In addition, their fees may be covered by an insurance policy with a “professional fee” or “claim preparation cost” endorsement.
The Forensic Accounting and Business Insurance Claims practices of Berkowitz Pollack Brant has more than three decades of experience helping Florida businesses prepare for and maximize financial recovery from insured perils.
About the Author: Daniel S. Hughes, CPA/CFF, CGMA, CVA, is a director in the Forensics and Business Valuation Services practice at Berkowitz Pollack Brant, where he works with businesses of all sizes on matters involving valuations, economic damages, lost profits and the quantification of business interruption insurance claims. He can be reached in the CPA firm’s Miami office at (305) 379-7000 or via e-mail at email@example.com.
The IRS this month issued temporary regulations that will give taxpayers who incurred losses from a federal disaster area an additional six months to claim those losses on their federal tax income tax returns.
Under Section 165 of the Internal Revenue Code, taxpayers may elect to deduct losses incurred from a federally declared disaster area. These casualty losses are typically deductible only for the taxable year in which the disaster and resulting damages occur or for the taxable year immediately before the year in which the disaster occurred, as long as the election is made by filing a return, an amended return, or a claim for refund on or before the later of (1) the due date of the taxpayer’s income tax return (determined “without” regards to any extensions) for the taxable year in which the disaster actually occurred, or (2) the due date of the taxpayer’s income tax return (determined “with” regards to any extensions) for the taxable year immediately preceding the taxable year in which the disaster actually occurred.
Effective immediately, a taxpayer will have six months after his or her original federal tax return due date of the year following a disaster to make a 165(i) election. That means that a taxpayer whose 2016 federal income tax filing deadline is April 15, 2017, will have until October 15, 2017, to deduct casualty losses incurred in 2016.
The taxpayer does not need to request an extension of time to file a federal tax return for the disaster year in order to benefit from the extended due date. In addition, under the newly issued Revenue Procedure 2016-53, taxpayers will receive an additional 90 days after the April federal tax deadline to revoke a 196(i) election for the previous year. According to the IRS, these filing extensions will provide taxpayers affected by storms, flooding, fires or other natural disasters more time to recover and decide whether they choose to make the election, without waiting for the IRS to respond to federal disaster declarations and extend filing deadlines.
Taxpayers who experiences losses due to a disaster should reach out to their accountants to understand their tax filing rights and responsibilities, to quantify damages to property and interruption of business operations losses and to identify opportunities to qualify for a casualty loss deduction.
About the Author: Angie Adames, CPA, is an associate director in the Tax Services practice of Berkowitz Pollack Brant, where she provides tax and consulting services to real estate companies, manufacturers and closely held business. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.