As the Southern California wildfires blaze on, people in the path of the flames may be making an unlikely wish: that if the damage happens, it happens before the clock strikes midnight on December 31. It's morbid, but practical — because now that the new tax bill has passed, some significant disaster tax deductions will disappear.
Right now, if a business or an individual endures losses from any type of disaster — be it a fire, flood, or robbery — they can deduct losses that exceed 10 percent of their adjustable gross income not covered by insurance or other reimbursements.
“Losses can include damage to your personal property and your small business if you file your business under your personal tax return,” said Julie Magee, director of tax regulatory affairs for Credit Karma Tax. “After a natural disaster, the IRS automatically identifies taxpayers in federally designated disaster areas to provide filing and payment assistance. Most notably, affected taxpayers can claim these disaster-related losses. They can also have some deadlines extended and any fees or penalties automatically waived.”
Under the new plan, the individual deduction is wiped out. Businesses will get to hold on to their deductions, kind of. They can make the deductions if their losses were caused by what the president officially declares a disaster. This caveat could effectively wipe out businesses that aren’t wealthy enough to be well insured. If your office burns down in a local blaze, or your warehouse gets flooded when the water heater bursts, or a thief steals all your merchandise, resulting losses are yours and your insurance company’s to bear, sans federal backup.
Arguably more frightful is the fact that the definition of a disaster in terms of tax-deductibility lies in the president’s hands. So, if President Donald Trump or other future occupants of the Oval Office don’t come out and proclaim, “Disaster,” then it doesn’t count come tax filing time. And your business can’t deduct a dime.
“This evolving tax bill leaves it all up to the whim and political priorities of the president,” Joe Heider, president of Cirrus Wealth Management, told NBC News. “And so you can make the argument that if a particular president wants to be very political in a state that his or her party does not favor, then they could not care if it’s a disaster, and not declare it one.”
Survival of the fittest — or those with the best insurance
Nearly 40 percent of small businesses never reopen after a disaster. Could that percentage swell if this tax bill passes because of this change in the disaster deduction policy? No one can yet say with certainty, but experts are leaning toward a strong yes, or at least, as Heider says, “the number certainly is not going to go down.”
It also means things will get tougher for mom and pop shops who may not be able to afford insurance, or whose insurance policies don’t cover total losses. And that could climb up to middle market businesses as well, and really any business that doesn’t have a premium, bulletproof insurance policy.
“Traditionally, business owners only insure what they think they need to insure or are what they’re told they have to,” said Peter J. Strauss, an attorney, captive insurance manager, and author. “They want to spend as little as possible on coverage, and they don’t want to have to think about it.”
Even businesses with disaster insurance that looks pretty decent could find themselves in the lurch because, as Strauss highlights, insurance policies contain exceedingly fine print, and it takes thorough investigation to be sure that all your bases are covered. And often it’s the seemingly little things that sprout up after a catastrophe that can be the most deadly.
“What tends to kill businesses after a disaster isn’t not being covered for the property, it’s not being covered for what keeps the lights on,” says Strauss. “An example would be: A business owner in Napa that sells wine and has a crop policy or a general liability policy or a worker’s comp but doesn’t have some kind of supply chain interruption policy, that could be crushing.”
Another seemingly small detail that could hurt businesses as they rebuild in the wake of ruin? The elimination of the deductibility of moving expenses. “Businesses will no longer be able to deduct moving expenses,” says Heider. “While we don’t yet know the nuances and interpretations [of this in the new tax bill], should a business owner or employee have to relocate after a disaster, those costs probably won’t be deductible.”
Most small businesses will just have to roll the dice
With so many potential losses on the horizon, will businesses rush to buy the swankiest insurance plans? Ideally, yes. But that’s not really an option for most businesses that must risk a gamble in order to cut a profit.
“Even if you want [the best insurance], if cash flow is tight, you'll see a lot of small businesses roll the dice a bit and not spend the money for things like business continuation insurance,” said Heider. “I don’t think you'll see an insurance boom because these businesses, especially the smaller ones, they just can’t afford it.”
Mark Aselstine, founder of the wine business Uncorked Ventures in the Bay Area, is an example of a small business owner who, having narrowly dodged the wildfires that recently ravaged parts of northern California, would like to upgrade his insurance. However, it’s probably not financially feasible, since his three-person operation preps for business to slow as its customers feel the new pains of their own tax deduction losses.
“I have to take my chances,” said Aselstine. “There are small steps I can take, like keeping as little inventory [on hand] as possible. But I have to worry about more day-to-day things like theft, which my insurance covers. It’s all still pretty confusing but I think for my business, there's no real upside. Sure, our tax rate is going to go down a bit, but if my local sales go down as a result of the raising of taxes here," then his bottom line is impacted, he told NBC News.
Insurance premiums will likely increase
Aselstine adds that if he only had to pay say, two percent more a year for better insurance, he’d probably opt in. But he’s thinking it would be higher than that. He’s right — and it will likely only get steeper as insurance companies look to protect their own gains.
“You will likely see fire insurance premiums dramatically increase in California,” said Heider. “Because of the change in climate, the risk of wildfires in the area is much greater looking ahead. From a pure business standpoint, if you own a restaurant chain and you're losing money in specific areas, you close those restaurants. If you're an insurance company who can't make money in certain states, you'll cease to do business in them.”
The long and winding road ahead
While it’s tough to see the wins for the small-to-mid-sized businesses beyond the 20 percent deduction of qualified business income (which caps at $157,500 of individual income, and $315,000 of income for couples filing jointly), there is currently no real way to predict what exactly will happen.
“Basically, what we will have is a new ball game, one that doesn’t have hard and fast rules for anyone,” said Dr. Steven J. Weil, President of Royale Management Services.
“Worse yet, changes do not replace the old code, but simply amend it, inserting changes, new sections and striking words, sections, and paragraphs. You can’t read the bill without referring to the existing tax code to find out just what is changing. Nor can anyone (even those who wrote it) be sure it will do just what they think it will do. There are sure to be errors and corrections that Congress will have to make. How long these will take and how many there will be is anyone’s guess. It could be years before the IRS does its interpretation of the tax changes and even longer, if ever, before those interpretations are tested by courts.”
What can small businesses do in the mean time? Make sure they have any 2017 deductions lined up, and going forward, prepare for the worst.