Contingency Planning for Small Business Owners

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Along with warm temperatures, summer can bring natural disasters. Across the country, residents are currently facing hurricane season along the Atlantic and Gulf coasts, severe storm season in the Midwest, flood season along the Mississippi River, and wildfire season in the Southwest and West.

When disaster strikes, affected businesses may incur substantial financial losses. However, some losses can be mitigated with proactive planning.

Collateral Damage

U.S. business casualty losses have skyrocketed in recent years, in part because there have been more catastrophic natural disasters than in the past. On average, there have been 6.3 natural disasters that cost more than $1 billion each year since 1980. By comparison, the annual average for billion-dollar disasters was 12.6 from 2014 through 2018 — double the historical average.

In 2018 alone, there were 14 catastrophic weather and climate disaster events with losses exceeding $1 billion each across the United States. The National Centers for Environmental Information (NCEI) estimates that the total losses for these disasters was $91 billion. What can your business do to protect against financial losses?

Insurance Coverage

Insurance is the most obvious way to hedge against natural and man-made disasters. But many small business owners don't bother to read the fine print of their insurance policies until after disaster strikes. Unfortunately, that may be too late.

Commercial property insurance doesn't typically pay for financial losses incurred while you're temporarily unable to reopen after a disaster. Instead, you'll need to add business interruption coverage as an addendum to your company's existing property insurance policy. This type of coverage allows a business to relocate or temporarily close so its owners can make the necessary repairs. In the meantime, it provides cash flow to cover revenues lost and expenses incurred while normal operations are suspended.

In general, there are two basic types of business interruption coverage:

1. Named perils policies. These cover only occurrences that are specifically listed in the policy, such as fire, water damage and vandalism.

2. All-risk policies. These cover all disasters unless they are specifically excluded. Typically, an all-risk policy excludes damage from earthquakes and floods, although coverage can generally be added for an additional fee.

For additional premiums, you can generally also add these endorsements to a policy:

Extended business interruption endorsement. This covers for a specified time the income lost after repairs are made but before income returns to levels achieved before the loss.

Contingent business interruption. This provides for loss of income that results from damage to the property of suppliers, providers or customers.

As with any insurance product, ask which disasters are specifically excluded from business interruption coverage. An insurance agent can help you understand the risks inherent to your geographic location, specific business and industry. Always read the fine print of the policy before you sign on the dotted line.

Pay close attention to your policy's indemnity clause, which can place a limit on the time an insurance company will pay for your loss of business. Also, beware of any clauses that require you to exercise "due diligence and dispatch" in the repair and construction process. This can be difficult because repairs aren't always under your control, particularly if you're a tenant.

Recordkeeping

It's critical to protect your business records — including insurance policies, bank account numbers, tax returns and personnel records — in case disaster strikes. Paper records can be safely stored in a fireproof safe and copies may be transferred off-site.

Many businesses have opted to go paperless, whenever possible. This includes receiving bank and credit card statements electronically, invoicing and collecting from customers with electronic payment applications and scanning employee records to save on storage costs.

However, going paperless doesn't eliminate the need to back up electronic files and store them — along with a list of key user names and passwords — in a safe, off-site location. When choosing a place to keep your important business records, convenience to your office shouldn't be your primary concern. Remember, a disaster that strikes your business is also likely to affect other facilities nearby, making quick retrieval of your records difficult and maybe even impossible.

Another smart business practice is maintaining an up-to-date listing of your business equipment. If disaster strikes, this step will help you recall and prove the market value of items for insurance and casualty loss claims.

Comprehensive Disaster Recovery Plan

Do you have formal written policies and procedures to guide you through a disaster and manage the aftermath? Many companies create a plan, but they don't update it as the business grows — or regularly review it with employees. Start by brainstorming disasters common to your geographic area or industry. Then develop a plan that considers:

  • Where to seek shelter from all types of hazards,
  • How to safely evacuate your facilities — and secure them from further damage and possible looting,
  • Where to obtain information from community warning systems,
  • How to back up your computer data systems and where to store backup data, and
  • How to communicate with employees (and their family members), customers and others when disaster strikes — and after.

The safety of workers should be your plan's top priority. In addition, you'll need a plan for notifying employees when the decision is made to close your business. Systems include website postings, social media, phone trees and recorded messages.

You also should have a procedure in place for employees to let you know when they can't make it in, even when you have decided to keep your doors open. Having multiple communication systems can help in cases where the power is out and, for example, Internet access isn't possible.

Depending on the nature of their jobs, many employees may be able to work from home if they can't make it out. Determine in advance who those employees are and how they should carry out their responsibilities.

Consider staging impromptu disaster drills to test how well your business and its employees are prepared. This allows you to unearth weaknesses in your disaster plan before lives and dollars are at stake.

Are You Adequately Prepared?

Proactive business owners expect the unexpected. Doing so can minimize the financial impact of a natural or man-made disaster, help restore and rebuild normal business operations after a catastrophic event, and possibly even save lives. Contact your financial advisors to devise a contingency plan that covers all the bases.

Claiming Casualty Losses on Your Tax Return

To the extent that losses from a natural or man-made disaster aren't covered by insurance, businesses may generally deduct them for federal income tax purposes. How much can your business deduct?

The term "casualty" means damage or destruction of property resulting from an identifiable event that's sudden and unexpected. This includes damage or destruction caused by natural disasters and events caused by humans, such as automobile collisions or water pipes bursting during a severe cold snap. Similarly, losses due to vandalism or theft of property can be deducted.

On the other hand, you aren't allowed to recoup losses due to normal "wear and tear" or progressive deterioration. For example, damage to shrubbery and plants caused by a long summer drought doesn't qualify for the casualty loss deduction. Neither does damage to a factory or warehouse from termites or other insect infestations over long periods of time.

If business or income-producing property (such as rental property) is destroyed, the casualty loss generally equals the lesser of:

  • The tax basis of the property immediately before the casualty event, or
  • The decrease in the property's fair market value (FMV) due to the casualty event.

The loss is also offset by any salvage value, insurance reimbursements and other recoveries. Not surprisingly, the decrease in FMV (if any) is a frequent point of contention between taxpayers and the IRS.

If your property is covered by insurance, you must file a timely insurance claim for loss reimbursement. Otherwise, you can't deduct a casualty or theft loss.

Important note: Casualty losses may be limited for individual taxpayers under the Tax Cuts and Jobs Act (TCJA). In general, for 2018 through 2025, deductions for personal casualty losses have been eliminated, except for losses due to federally declared disasters.

Contact your tax advisor for more information or for help calculating the casualty loss deduction for business or personal-use property.

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