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Recovery with a Hand from Uncle Sam

Few professional risk managers predicted or planned for the battering suffered by Florida-based businesses in 2004. Few businesses in the Gulf region could have predicted or obtained insurance against the tremendous damages produced by Hurricane Katrina, Rita or Wilma.

By Mark E. Battersby

Congress’s watchdog, the Government Accountability Office (GAO) recently reported that much of the funding earmarked to help businesses get back on their feet in New York City after 9/11 obtained fraudulently or never repaid. Now Congress has voted to “unfund” a great deal of unused 9/11 aid.

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  • Fortunately, when risk management fails and insurance proves inadequate to cover a sign operation’s losses, our federal tax laws are usually there to help ease some of the financial strain.

    The havoc wrought by the hurricanes in the Gulf resulted in federal legislation, the Katrina Emergency Tax Relief Act of 2005, aimed largely at individuals impacted by the devastation of Katrina. That law permitted penalty-free withdrawal by sign professionals and business owners from IRAs and other qualified retirement plans, funds that could be used to keep their businesses afloat. The law expanded the work-opportunity tax credit and the new-employee-retention credit. The law also extended the non-recognition of gain replacement period. A second bill, one that will provide more financial assistance to affected businesses in all of 2005’s major disaster areas, remains tied up in Congress.

    The Internal Revenue Service did not wait for Congress and provided help in their unique manner. That help took the form of postponed deadlines for the filing of many tax and information returns as well as later deadlines for the payment of taxes by many of those affected.

    However, it is our basic tax law, the Internal Revenue Code that continues to provide the bulk of relief for sign businesses and their owners - even those who suffer losses in areas that do not receive the publicity given recent disasters.

    Casualty Losses
    Generally, the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected or unusual, qualify as a ‘casualty loss.’ Casualty losses are, of course, tax deductible ­ if the sign operation’s owner or manager can prove that a loss occurred and can put a value on the amount of that loss.

    Simply misplacing or losing property does not qualify as a tax-deductible casualty, even though an insurance company may consider it a reimbursable loss. Naturally, if property is lost in conjunction with another accident or casualty, it may qualify.

    With casualty losses, the rules limit the tax deduction amount to the lesser of 1.) the difference between the fair market value (FMV) of the property immediately before the casualty and its FMV immediately after, or 2.) the adjusted basis (book value) of the property immediately before the casualty.

    Obviously, if the sign business or income-producing property is totally destroyed, the amount of the casualty loss is the adjusted basis of the property regardless of its FMV.

    Also labeled as casualty losses, are embezzled or stolen money. The theft loss is the amount actually stolen. In the case of stolen business or income-producing property, the loss is the adjusted basis of the property stolen.

    When there is damage to different kinds of business property, losses are separately computed for each identifiable property damaged or destroyed.

    Proving the unthinkable
    In order to claim a tax deduction for any casualty loss, it is often necessary to prove it. Specifically, if the operation’s income tax return is audited, it may be necessary to show all of the following:

    • that the operation owned the property,
    • The amount of its basis or book value in the property,
    • The pre-disaster value of the asset,
    • The reduction in value caused by the disaster or other casualty, or
    • The lack or insufficiency of reimbursement to cover the costs.

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    Naturally, for any sign business to claim the casualty loss deduction, the property must be owned by the business. Therefore, the sign business cannot claim a loss for the destruction of property owned by a manager or employee. If more than one person owned the property, the loss is allocated among the owners in proportion to their ownership interests.

    Remember, if a lease or rental agreement for property used in the business requires payment for any damages resulting from a casualty, then that loss, too, will qualify as a casualty loss.

    Proving the book value or basis of business property is generally not a problem ­ if the sign operation’s records have not suffered a fate similar to the property lost. The tax-deductible loss is usually the property’s original cost plus any additions or subtractions to the basis made for tax or accounting purposes.

    Although not specifically required by our tax rules, a professional appraisal is often the best evidence or proof of property value before and after a casualty. Ideally, the appraiser should be someone who is at least familiar with the types of property involved; their values before and after the casualty and who uses conventionally accepted appraisal methods.

    For the record, the cost of obtaining an appraisal is not itself part of the casualty loss but it can be deducted as a legitimate business expense.

    While professional appraisals are nice to have, they are not always required, especially with inexpensive items. An insurance adjuster’s appraisal may do just as well. For damaged property, the casualty loss is usually the cost of cleaning it up or repairing it to bring it back to its condition before the casualty. This is a measure of the difference in fair market value (FMV) before and after the casualty so long as the repairs do not actually increase the property’s value above its pre-casualty value.

    Gaining from a loss
    Surprisingly, a number of sign professionals and their businesses have profited from their casualty losses. If, for instance, the amount of the insurance reimbursement received is more than the adjusted basis of the destroyed or damaged property, there may actually be a gain. Fortunately, the fact that a gain exists does not necessarily mean that it will be taxable right away. Most businesses are able to defer the gain to a later year (or perhaps indefinitely) if “qualified replacement property” is purchased.

    In calculating that gain, any expenses incurred in obtaining the reimbursement, such as the expenses of hiring an independent insurance adjuster, are subtracted from the reimbursement. Then, if the same amount as the rest of the insurance money received was spent either repairing or restoring the property or in purchasing replacement property, tax on the gain may be postponed. Of course, the replacement must occur within two years of the end of the tax year the gain was realized.

    The replacement property must be similar or related in use to the property destroyed. If the property was investment real estate, then other investment real estate will qualify as a replacement. If, however, the property was business or income-producing property located in a federally declared disaster area, any business-use property will qualify.

    Disaster business losses
    To help cushion losses suffered by sign businesses and others, the tax laws contain a special rule for losses incurred from a disaster in an area subsequently determined by the President of the United States to warrant federal assistance. For those losses, the sign business owner or manager has the option of:

    • deducting the loss on the tax return for the year in which the loss occurred, or
    • choosing to deduct the loss on the tax return for the preceding tax year.

    In other words, the sign business has the option of deciding whether their loss would be most beneficial offsetting the current year’s tax bill or if used to reduce the previous year’s tax bill ­ generating a refund of previously paid taxes.

    Temporary tax relief
    Soon after Hurricane Katrina struck, and again after Hurricanes Rita and Wilma, the Internal Revenue Service announced that those affected were eligible for tax relief. Deadlines for affected taxpayers to file returns, pay taxes and perform other time-sensitive acts were postponed until February 28, 2006.

    Affected taxpayers eligible for the postponement of time to file returns, pay taxes and perform other time-sensitive acts are those taxpayers who live in and businesses whose principal place of business is located, in the covered disaster areas. Taxpayers not in the covered disaster areas but whose books, records or tax professionals’ offices are in the covered disaster areas, are also entitled to relief.

    The IRS assures everyone that it will continue monitoring the aftermath of the hurricanes and resolve other potential tax administration issues as they arise. Further federal assistance will also be forthcoming once lawmakers resolve their differences. For all others, the basic tax rules governing casualty losses, including the special rules for losses in federally declared disaster areas, remain the only option. Fortunately, that option can go a long way toward helping ease the financial burden of many sign professionals and businesses resulting from casualty losses.

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