Imagine a well-loved local restaurant suffers considerable damage from a fire. The physical damage is extensive enough to require the restaurant to close temporarily for repairs. To protect against such incidents, the restaurant has business interruption insurance.
Business interruption insurance steps in to cover lost income during periods when a business cannot operate due to physical damage, as in the case of our restaurant. The insurance payout in this scenario compensates for the revenue the restaurant would have earned if it hadn’t been for the fire-induced closure.
It’s crucial to differentiate this from payouts for personal property loss. Generally, personal property insurance payouts are not taxable because they’re compensating for a loss, without creating a financial gain. However, the situation is markedly different for the restaurant.
In our example, the restaurant was projected to earn $150,000 during the period it is closed for repairs. If the business interruption insurance covers this amount, it effectively replaces the restaurant’s lost income. This is where the tax implications come into play. Unlike the compensation for the physical damage to the property, which is not taxable, the payout for the lost income is taxable. It’s seen as a stand-in for the earnings that the restaurant would have made, which would have been subject to taxation under normal business operations.
This scenario underscores the importance for businesses to not only have the right insurance coverage but also to understand the tax implications of these policies. When a business receives a payout that compensates for lost income, as in the case of business interruption insurance, it’s often treated as taxable income.
It is crucial for business owners, like our restaurant proprietor, to consult with trusted advisors for both their insurance coverage and their tax strategy. This ensures they’re not only recovering from their physical losses but also managing their financial responsibilities effectively, particularly when it comes to understanding and handling potential tax liabilities from insurance payouts.
Jason Hamsher is a licensed Property & Casualty and Life Insurance Agent in Ohio and South Carolina. He has over a decade of experience helping business owners find a path forward when the unthinkable happens to their business.