A federal emergency declaration triggers a number of tax provisions that clients can use to get financial relief while weathering the impact of the storm. While IRC Section 165(i) is most commonly accessed in the wake of an actual storm or other natural disaster, it was activated when the president declared a nationwide emergency in response to the COVID-19 pandemic on March 13, 2020.
Section 165(i) may be particularly useful to small business clients because it allows them to deduct 2020 COVID-19 losses on last year’s return—meaning that Section 165(i) could provide financial relief right now, without the need to wait and file the 2020 return, by which time it might be too late for many small business owners.
Basic Rules of Section 165(i) Disaster Relief
Section 165(i) does not allow a deduction for all general losses, but even in the absence of the physical damage caused by a natural disaster, many small business clients can benefit from current tax relief by accelerating COVID-19 losses to 2019.
When Section 165(i) is triggered, it gives taxpayers the option of taking a loss deduction for the year before the year in which the loss was actually sustained. Although COVID-19 losses were obviously sustained in 2020, the client has the option of treating those losses as though they were sustained in 2019 for tax purposes. Without Section 165(i), taxpayers would have to wait until they filed their tax return for 2020 to claim COVID-19 related losses.
To claim a loss under Section 165(i), the taxpayer must be able to show that property losses were directly caused by the COVID-19 pandemic (i.e., the “identifiable event” requirement). The client must further document that (1) the loss could not be reimbursed through insurance or otherwise, (2) the loss can be evidenced by “closed and completed transactions” and (3) the loss was related to the disaster and sustained in the year when the disaster occurred.
Section 165(i) is particularly beneficial for clients with inventories that have been impaired by COVID-19. Taxpayers have the option of choosing whether to account for those losses through inventory adjustments or the disaster loss provisions in this type of situation—they are not permitted to attempt to claim losses through both systems. Inventory sold at a loss, donated to charity or that expired or spoiled due to store or restaurant closures can all be deducted as Section 165(i) losses.
Clients who have permanently closed store locations, abandoned pending business deals (for costs already capitalized), and made termination payments based on cancelled contracts or deals can also benefit from accelerating those losses back to 2019. Similarly, a client who lost money because of pre-paid business travel, or pre-payment on materials where the contract was cancelled, may be eligible (assuming the amounts were not reimbursed from insurance or another source).
For some taxpayers, pushing the 2020 losses into 2019 could even generate a larger net operating loss (NOL), which can now be carried back to earlier tax years when the business may have been more profitable.