GS Editor

In recent years, many businesses have been pounded by a wide variety of disasters, natural and man-made. From coast to coast, some businesses have fought to keep their doors open despite floods, wildfires, hurricanes, mudslides, vandalism, riots and more. These disasters serve as sobering reminders to expect the unexpected.

Your business could become a victim of Mother Nature or other external forces without warning. After a disaster, an estimated 25% of companies are unable to reopen. Depending on your business and its financial stability, a few weeks of lost income can be enough to close your doors indefinitely.

Being Prepared for Disruption

Commercial property insurance doesn’t typically pay the cost of disrupted operations. What can help you survive is business interruption coverage. This insurance allows you to relocate or temporarily close so you can make the necessary repairs — and still be provided with cash flow to cover lost revenue and expenses incurred while normal operations are suspended.

Before the next disaster strikes, consult with your insurance agent about business interruption coverage. To determine the proper amount of coverage, your financial adviser can help forecast a worst-case scenario and ask “what-if” questions to cover all possibilities. You don’t want to over insure, but you also don’t want to overlook critical risks, such as a long power outage.

Business interruption insurance isn’t sold as a separate policy. Instead, it’s added to your existing property insurance policy. There are two basic types of coverage:

  1. Named perils policies cover only specific occurrences that are listed, such as fire, water damage and vandalism.
  2. All-risk policies cover all disasters unless they’re specifically excluded. Most all-risk policies specifically exclude damage from earthquakes and floods, but such coverage is generally available for an additional fee.

What is covered? Business interruption insurance usually pays for income that is lost while operations are suspended. It also covers continuing expenses, including salaries, payroll costs and other costs required to restart a business. Depending on the policy, additional expenses might include:

  • Relocation to a temporary building (or permanent relocation if necessary);
  • Replacement of inventory, machinery and parts;
  • Overtime wages to make up for lost production time; and
  • Advertising to announce your business is still operating.

Business interruption coverage that insures you against 100% of losses can be costly. Policies typically cover 80% of losses while you shoulder the remaining 20%. After your business selects coverage to suit your needs, make sure you have a copy of the policy offsite so you can access it quickly if a disaster occurs.

Know Your Policy and Act Quickly

The key to continuity after a disaster is to file the proper insurance claims as soon as possible. But be warned: This type of insurance is complicated. Submitting a claim can be time consuming and requires careful consideration. Follow these steps as soon as it’s feasible:

Notify the insurer about the damage. If your actual policy has been water damaged or destroyed, ask the company to send you another copy.

Review the policy. Read your policy in its entirety to determine how to best present your claim. It’s important to understand the policy’s limits and deductibles before spending time documenting losses that may not be covered.

Minimize losses. Make temporary repairs if possible and hire security guards if necessary to protect property. Then:

  • Reopen as soon as practical, even if it’s only for a limited number of hours.
  • Block off unusable parts of the building and operate from less-damaged areas.
  • Post updates on your website and social media announcing when you’ll reopen. Consider taking out newspaper, radio or television ads to make announcements.
  • Consider layoffs of nonessential support staff to limit continuing operating expenses.

Record losses. Maintain accurate records to support your claim. Reorganize your bookkeeping to segregate costs related to the business interruption. Among the necessary documents are:

  • Pre-disaster financial statements and income tax returns;
  • Post-disaster business records;
  • Copies of current utility bills, employee wage and benefit statements, and other records showing continuing operating expenses;
  • Receipts for building materials, a generator and other supplies needed for immediate repairs;
  • Paid invoices from contractors, security personnel, media outlets and other service providers; and
  • Receipts for rental payments, if you move your business to a temporary location.

Be as precise as possible, or your claim may be delayed or denied. Your accountant can review the records you plan to submit and organize them in anticipation of litigation if the insurer is reluctant to pay your claim. Taking the time to prepare for that possibility — even if it’s remote — can save effort later.

Get Professional Assistance

The calculation of losses in business interruption insurance claims is complex and potentially contentious. Your accountant can be the primary contact with the insurer. Depending on the scope of a loss, the insurance company may enlist its own specialists to audit your claim. So you also may want to consult with an accountant who is experienced in business valuation and litigation support to help prepare your claim, quantify losses and anticipate questions from your insurer.

Are Business Interruption Proceeds Taxable?

Insurance proceeds received for the loss of property generally aren’t taxable if you use the money to purchase replacement property. But business interruption proceeds are fully taxable to the extent that they’re used to replace lost income.

Cash basis entities that file an undisputed claim with an insurance carrier must pay tax when they receive payment. For accrual basis taxpayers, the general rule of thumb is: Where liability is undisputed by the insurer and the amount of the recovery can be reasonably approximated, income accrues in the year of the loss, despite the fact that the amount of the recovery may not be known at the time of accrual.

For accrual basis entities, the timing of the tax liability is less straightforward if a business interruption claim is in dispute. To determine whether the proceeds should be recognized in the year the claim is filed, the IRS considers two main issues:

  • Has the insurer recognized a liability for your claim?
  • Can your proceeds be reasonably approximated?

The timing of tax liability hinges on the facts and circumstances. Sometimes, claims aren’t includible in taxable income until the litigation between the parties is settled and the amount is set. Consult with your tax adviser.

Improve Your Odds of Survival

It’s impossible to know when natural and man-made disasters will cause substantial damage. Business interruption insurance obviously won’t solve all your problems if disaster strikes, but it can improve your odds of survival. Work with your accountant to quickly and efficiently assemble the information and calculations needed for a viable claim. Filing a well-crafted claim can result in a faster, easier resolution — and provide much-needed cash to get your business up and running again.