Chiropractic News

Uncle Sam’s helping hands
By Mark E. Battersby

Losing money is never good. And it is especially distasteful when you consider it is not considered a tax-deductible event.

Although losing money on your business is not tax-deductible, other types of losses may be tax-deductible. And those losses may actually be profitable, thanks to our tax laws.

Under tax rules, any loss sustained during the taxable year — a loss not covered or “made good” by insurance or some other form of compensation — may be claimed as a tax deduction. However, for any loss to be deducted, it must be a so-called “closed and completed transaction.” Naturally, only a bona fide loss, as defined by our lawmakers, is allowed.

CASUALTY LOSSES

Most losses involve what the Internal Revenue Service defines as casualty losses — damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Embezzled or stolen money is also considered a casualty loss.

Casualty losses are generally tax-deductible, provided you can prove that a loss occurred and are able to establish the amount of that loss.

With casualty losses, the actual tax-deductible loss is usually the fair market value (FMV) of the property “immediately before and immediately after the casualty shall be ascertained by competent appraisal,” as the tax rules dictate. This appraisal must recognize the effects of any general market decline that affects undamaged, as well as damaged, property that may have occurred simultaneously with the casualty.

In other words, the tax deduction is limited to the actual loss resulting from damage to the property — not an overall decline in property values. Alternatively, the cost of repairs to the damaged property is acceptable evidence of the loss of value.

PROVING THE UNTHINKABLE

To claim a tax deduction for any casualty loss, you may need to prove the loss, as well as document it. Specifically, should income tax returns of the chiropractic practice — or those of its principals — be audited, you may need to show all of the following:

• Ownership of the property;

• The amount of the book value (basis) of the property;

• The pre-disaster value of the asset; and

• The reduction in value caused by the disaster or other casualty, the lack of reimbursement, or the insufficiency of the reimbursement to cover the loss.

Naturally, if a lease or rental agreement for property used in the practice 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, provided your practice’s records have not suffered a fate similar to the property lost. The tax-deductible loss usually equals the property’s original cost plus any additions or subtractions to the basis made for tax or accounting purposes.

Although it is not always required by our tax rules, especially for smaller casualty losses, 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 one who uses conventionally accepted appraisal methods.

Although 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 the record, the cost of obtaining an appraisal is not itself part of the casualty loss, but it is tax-deductible as a legitimate business expense.

INVOLUNTARY CONVERSIONS

Far more common than disaster losses are instances of business property that is taken, legally or illegally. The government may, for example, legally take property by the simple act of “condemnation.” This type of loss is usually labeled as an involuntary conversion.

Involuntary conversions are unusual because they often produce a gain. For example: The local government that condemns your parking lot is required to reimburse you. That reimbursement frequently exceeds your book value (basis) for that property, resulting in a taxable gain.

Fortunately, the rules governing involuntary conversions permit the property to be replaced with property of a “like kind” and eliminate the need to report and pay taxes on that gain. Instead, the basis of the old “lost” property becomes the book value of the new property, and you postpone the taxable gain to some date in the future.

ABANDONMENT

Finally, you can control some losses. A tax deduction is, for instance, allowed for the abandonment of an asset. All you must do is “manifest an intent to abandon the asset and make some affirmative act of abandonment.” The resulting loss generally equals the adjusted basis or book value of the abandoned property.

If a depreciable business or income-producing asset loses its usefulness and is abandoned, the loss is its adjusted basis. Naturally, the abandonment loss must be distinguished from anticipated obsolescence.

If an asset, such as land, a mailing list, or other nondepre-ciable asset, is abandoned following a sudden termination of its usefulness, a loss is also allowed in an amount equal to its adjusted basis. This applies to the abandonment of an enterprise, as well as to the abandonment of intangible assets, such as contracts.

GAINING FROM A LOSS

Surprisingly, you may gain from a casualty loss. For instance: If the amount of the insurance reimbursement received is more than the adjusted basis of the destroyed or damaged property, you may actually gain.

Fortunately, the fact that a gain exists does not necessarily mean it will be taxable right away. Most practices are able to defer the gain to a later year (or perhaps indefinitely) if “qualified replacement property” is purchased.

To calculate that gain, subtract from the reimbursement any expenses incurred in obtaining the reimbursement, such as the expenses of hiring an independent insurance adjuster. Then, if you spend the same amount as the rest of the insurance money received on either repairing or restoring the property or on 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 in which the gain was realized.

TOO MANY LOSSES

When the expenses of your chiropractic practice exceed its income, a loss occurs. If the business has too many tax deductions and too little income, for example, the result is a net operating loss (NOL) for the business.

Generally, a NOL may be carried back to the two years preceding the loss year, and forward for 20 years following the loss year. The result is either a refund of taxes paid in the carryback years — a welcome addition to the cash flow of any troubled chiropractor — or, the NOL can reduce taxable income in future years until the carryforward is exhausted.

Unfortunately, NOL deductions are not permitted for partnerships or S-corporations, although S-corporation shareholders and partners in partnerships may use their distributive shares of any NOL to calculate individual NOLs.

While lost profits rarely qualify as a legitimate tax deduction, deductions for many other types of losses exist. The question is: Are you making the most of your chiropractic practice’s losses?

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer, and author with offices in suburban Philadelphia. He can be contacted at 610-789-2480.

DISCLAIMER: The author is not engaged in rendering tax, legal, or accounting advice. Please consult your professional advisor about issues related to your practice.