After Fires, What Next for Businesses?

As part of the recovery, small business owners should take the opportunity to be sure they're fully insured and protected against the next disaster

by Karen E. Klein

There's no official tally yet, but it's a safe bet that dozens—if not hundreds—of Southern California small businesses were lost (BusinessWeek, 10/24/07) in the recent wildfires. The owners of many suburban hair salons, sandwich shops, and dry cleaners will be dealing with their insurance companies in the coming weeks and trying to figure out when—or if—they can get back to business. Tim Good, a partner in Los Angeles accounting firm Windes & McClaughry, spoke recently to Smart Answers columnist Karen E. Klein about practical steps small business owners can take after a fire or any natural disaster. Edited excerpts of their conversation follow.

We've written in the past about disaster preparedness (BusinessWeek, 6/19/06), and how all businesses should take steps to prepare. But what should owners do if they are generally unprepared when informed of an immediate danger, like a wildfire, flood, or hurricane?

If I were sitting in my small business and I was informed of an evacuation, I would gather up the financial records that form the guts of my business: Pending orders, customer lists, copies of ledgers, inventory data, backup accounting records, employee and personnel records, tax returns, insurance policies, and receipts for equipment. If I had time, I'd take pictures of my business premises to document my equipment and inventory. You're entitled to reimbursement for that stuff if you're insured. If you can, take your computers and definitely your server, if it's on site.

If your company was insured for fire damage, what kind of recovery would you expect?

That all depends on what your coverage was, so you'd have to talk to your insurance carrier. Those photos you take and the other documentation you have about your building, your equipment, and other assets will be the key to obtaining the maximum insurance recovery possible. The other coverage you may have is business interruption insurance, which pays you for the weeks or months when your business is closed or your revenues reduced due to the disaster.

It's my sense that many small businesses do not have business interruption insurance, which is not inexpensive. If they don't have that coverage, their income will obviously be down for a certain period of time, and their tax payments—if they're paying quarterly—can be lowered accordingly. If a spouse is working outside the business, one consideration might be to have the spouse reduce his or her income tax withholding to bring more money in. This could work out because if you file a joint income tax return, it's likely that the overall household tax liability will be lower.

What are the tax implications for businesses hit by major disasters?

Tax law considers a compensated casualty to be treated the same as a sale of the assets you lost. So if I had a sandwich shop with counters, slicing machines, and refrigerators as my assets, and I get burned out and my insurance company writes me a check for the fair market value or the replacement value of those assets, the tax law regards that as a sale of the assets.

So an insurance reimbursement payment would be counted as income?

Only if you don't reinvest that money. If you use it to purchase new or used equipment to get your business running again, there's no tax due because you are rebuilding your company. But say I was tired of running that sandwich shop, and maybe this fire was just what I needed. In that case, if I got insurance money and kept it instead of using it to reopen the shop, I'd have a taxable event.

How much would be taxed?

You'd compare how much you got from the insurance company with what your cost basis for that equipment was when you lost it. It depends on what kind of depreciation deduction you've taken on the asset since you purchased it. The depreciation deduction reduces the cost basis of the asset dollar for dollar.