Cash flow is top of mind for business owners as the business disruption caused by COVID-19 is taking a toll. Business owners are rapidly looking for cash inflows to cover the cash outflows, which may result in additional debt, change of business model, and cash infusion by owners and investors. There may be another opportunity which is to potentially take advantage of accelerating losses in 2019 to get the cash your business needs now, versus waiting until your 2020 taxes are filed. IRS Section 165(i) addresses casualty losses for disaster victims and typically is top of mind when an area is declared a disaster due to a natural disaster that destroyed property. While the majority of the losses resulting from COVID-19 are to business operations rather than property, there may be opportunity for some businesses who have qualifying losses to use this, making it important to be aware of the rules and potential benefits it can provide.
For companies experiencing financial loss due to the COVID-19 economic crisis, finding ways to quickly increase cash flow is a top priority. One opportunity that should be considered is claiming COVID-19 losses on your business federal income tax returns.
Accelerating Losses from COVID-19 on Your 2019 Business Income Taxes
On March 13, 2020, the President issued an emergency declaration under the Robert T. Stafford Disaster Relief and Emergency Assistance Act in response to the ongoing COVID-19 pandemic. This allows businesses to utilize IRS Section 165(i) which says “companies experiencing financial loss due to natural disasters may accelerate those losses to the fiscal year immediately preceding the disaster event.”
For the 2019 calendar tax year, business owners have until the fall of 2021 to file an original or amended tax return to make this election. The business owner has the burden of proving the existence of the casualty as the cause of the Section 165 loss. The mere showing of a loss, without establishing it was caused by a casualty, will not suffice. In addition, you must establish that the loss was a direct, rather than an indirect, result of the casualty.
In order to claim a loss under Section 165, all of these must be true:
- Compensation for the loss can’t come from insurance or anywhere else.
- The loss must be caused by an identifiable event, which in this case is COVID-19.
- It must be evidenced by closed and completed transactions.
- The losses sustained must relate to the disaster event and must be sustained during the taxable year of the event.
- Closure costs of store and facility locations.
- Complete abandonment of leasehold improvements.
- Disposal of inventory, supplies, and other property that have become unsaleable due to spoilage or otherwise.
- Permanent abandonment of fixed assets.
- Losses from the sale or exchange of property.
- Costs of terminating business transactions for costs otherwise capitalized.
- Payments made to terminate contracts, leases, or licenses.
- Prepaid events, travel, conference space, hotel rooms, etc. when a refund or credit was not provided
- Worthless securities.
What Does Not Qualify?
- A decline in fair market value of the property.
- Lost revenues.
- Goodwill losses are difficult to write off under Section 165 because careful analysis needs to be considered and documented.
How will the COVID-19 Pandemic Affect Tax Deductions?
If you have a 2020 Section 165(i) loss that you accelerate into 2019 and it creates a tax loss, you can also take advantage of the newly issued net operating loss (NOL) carryback allowance under the CARES Act. The CARES Act provides that NOLs incurred in 2018, 2019, and 2020 may be carried back to offset taxable income during the five-year period prior to the year in which the NOL was incurred. The CARES Act also temporarily removes the taxable income limitation allowing taxpayers to utilize NOLs to offset 100% of taxable income in tax years 2018, 2019, and 2020.
The rules governing casualty losses may not apply because the losses are to business operations, rather than property. If you own a building, it’s not worthless but it may not be useable for the next few months. Just because it doesn’t destroy buildings doesn’t mean COVID-19 isn’t negatively impacting businesses. Net operating losses (NOLs) will occur and taxpayers can mitigate NOLs through carry-forwards and carry-backs. So while the company that owns the building can’t claim a loss of the building itself, it can claim the loss of income against past or future tax filings.
This current disrupter took business owners by surprise and is challenging even in the most well-thought-out contingency plans. It has resulted in business shut-down, slow-down, or quick reinvention in what the business does and how it does it. As the COVID-19 crisis continues to affect businesses, it is imperative to review all options available to business owners regarding government funding programs as well as tax relief opportunities.
SVA Certified Public Accountants has resources available at SVAaccountants.com/COVID19. Sign up for our tax eAlerts, Biz Tips, and webinars to stay informed.
©SVA Certified Public Accountants