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 to determine when to claim COVID-19 losses on an organization’s federal income tax returns. Should you wait until filing 2020 federal income tax returns, or is it better to accelerate losses to 2019?
Accelerating losses due to natural disasters
Under section 165(i), companies experiencing financial loss due to natural disasters may accelerate those losses to the fiscal year immediately preceding the crisis event. When the event is recognized and approved by the President as warranting assistance from the federal government under the Disaster Relief and Emergency Assistance Act, section 165(i) is activated.
On March 13, 2020, the President of the United States issued an emergency declaration under the Robert T. Stafford Disaster Relief and Emergency Assistance Act in response to the ongoing Coronavirus Disease 2019 (COVID-19) pandemic (Emergency Declaration). This declaration creates the opportunity to claim losses attributable to COVID-19 on a 2019 return, reducing current income and reducing cash tax payments to the government or potentially allowing for refunds of prior year taxes paid.
In order to claim a loss under section 165, all of the following must be true:
- Compensation for the loss cannot come from insurance or otherwise;
- The loss must be caused by an identifiable event;
- It must be evidenced by closed and completed transactions; and,
- The losses sustained must relate to the disaster event and must be sustained during the taxable year of the event.
The amount of the loss will (in general) be the taxpayer's basis in the asset, less any amount realized on its disposition.
What qualifies, what does not?
The following are examples of potential losses that could be claimed in 2020, but accelerated to 2019, if directly attributable to COVID-19:
- Inventory scrapped due to spoilage during government shutdown;
- Worthless securities (but not bad debts);
- Closure costs of store and facility locations;
- Complete abandonment of leasehold improvements;
- Permanent retirement of fixed assets;
- Abandonment of pending business deals for costs otherwise capitalized;
- Termination payments to cancel contracts, leases or licenses;
- Prepaid events, travel, conference space, hotel rooms, etc. when taxpayer is not provided a refund or credit;
- Prepaid raw materials or other items to fulfill a contract and the contract has been cancelled;
- Mark-to-market securities; or
- Losses from the sale or exchange of property.
Some losses generally would not qualify to be accelerated to 2019 under section 165. Examples include:
- A decline in fair market value of the property due to ’economic obsolescence‘ attributable to buyer resistance which attached to the property;
- An appraisal reflecting a potential buyer resistance which represents speculative estimates of rental loss;
- Lost revenues; or
- Goodwill losses are difficult to write off under section 165 and the facts and circumstances need to be carefully analyzed.
Making the election
A taxpayer makes the election on an original federal tax return or an amended federal tax return filed on or before the date that is six months after the original due date for the disaster year (determined without regard to any extension of time to file). This means that for the 2019 calendar tax year a taxpayer could have until the Fall of 2021 to file an original or amended tax return to make this election.
The taxpayer 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 that a casualty caused it, will not suffice. In addition, you must establish that the loss was a direct, rather than an indirect, result of the casualty, in this case COVID 19. Taxpayers have a limited time to elect to accelerate these losses.
In order to navigate this opportunity, please reach out your tax advisor.