Many businesses in 2020 are looking for access to cash. Many taxpayers are also evaluating whether they are able to recognize deductions in 2019 or 2020 to maximize the potential benefit for tax savings and access to cash, such as carrying losses back to prior tax years to obtain refunds of taxes paid in prior tax years. Identifying and recognizing disaster losses related to the Coronavirus Disease (COVID-19) can provide this flexibility.
Accelerating Deductions for Disasters
On March 13, 2020, the President declared the ongoing Coronavirus Disease (COVID-19) a pandemic of sufficient severity and magnitude to warrant an emergency declaration for all states, tribal territories and the District of Columbia pursuant to the Robert T. Stafford Disaster and Emergency Assistance Act.
This declaration by the President may present an opportunity to categorize losses due to COVID-19 as disaster losses. Businesses can choose to recognize a disaster loss in the tax year the loss occurs or in the prior year. That is, a business can recognize a loss on its 2019 tax return for a qualifying disaster loss that occurred in 2020.
A business may choose to recognize the loss on its 2019 tax return to reduce the amount of tax due when it files its 2019 return or, in the case of creating or increasing a net operating loss, carryback the loss and claim the deduction in a tax year with a higher tax rate.
Alternatively, a taxpayer may choose to deduct the loss on its 2020 tax return to reduce the amount of its current estimated payments, possibly also increasing a 2020 loss for carryback.
A disaster loss must satisfy the following criteria for deduction:
- Losses occurred in declared disaster area
- Attributable to a federally declared disaster, such as COVID-19
- Must be evidenced by closed and completed transactions
- Fixed by identifiable events
- Does not include amounts covered by insurance or other compensation
- Losses actually sustained during the taxable year
The amount of the loss is generally the adjusted basis of the property, adjusted for depreciation claimed, insurance compensation received and costs incurred to abandon or dispose of the property. The amount of the loss cannot exceed the basis in the property.
It is important that businesses sufficiently document the criteria above to substantiate that the loss is a direct result of COVID-19. Merely assuming a loss is associated with COVID-19 is not sufficient. Taxpayers should document facts and events identifying the amount and occurrence of a loss as a result of COVID-19. The loss must be evidenced by a closed or completed transaction – such as a permanent disposition of property or donation of inventory. Temporary decreases in value due to market fluctuations or a loss of revenues do not qualify as eligible disaster losses. The business must realize an actual loss of an asset.
Examples of costs potentially eligible for disaster losses include:
- Perishable inventory
- Destroyed crops and livestock
- Abandoned leasehold improvements
- Complete disposition of fixed assets
- Costs incurred to facilitate disposition of assets or inventory
- Complete abandonment of certain merger and acquisition (M&A) deals and capitalized costs incurred
- Costs and fees related to termination of certain agreements or contracts not reimbursed by insurance or other compensation
How and When to Claim the Deduction:
For a COVID-19 disaster loss occurring in 2020 that the business chooses to recognize in 2019, the business must attach an election to an original or amended tax return for the 2019 tax year. This election must be made no later than the extended due date – including extensions, regardless of whether an extension was filed – of the 2020 federal income tax return. The disaster loss is then recognized as a deduction on the 2019 original or amended tax return.
Businesses choosing to recognize the disaster losses in 2020 will report those losses on their 2020 federal income tax returns.
Potentially Impacted Industries
Below are industries that may be eligible for a disaster loss, depending on each business's unique facts and circumstances.
- Restaurants and food vendors
- Farming and agriculture dispositions of harvests or livestock
- Medical practices and hospitals with perishable drugs or equipment with limited shelf-life
- Businesses with seasonal inventory
The amount and whether certain costs or assets are eligible for the disaster loss deduction are not always clear and will require a case-by-case analysis. Businesses that may have sustained a disaster loss should conscientiously qualify and document their disaster losses. Please contact your tax advisor for assistance identifying disaster losses and the amount of the deduction.
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