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SMALL BUSINESS | FINANCING AND INSURANCE

Tax Returns Give Insurer Inaccurate Picture of Value

October 28, 1998|JUAN HOVEY

Imagine this:

* Fire races through your physical plant, ruining inventory and equipment and leaving you shellshocked and bewildered.

* Your insurance adjuster, noting that the fire has destroyed your paper records, asks to see copies of your federal and state income tax returns.

* Thinking that this will help fix the value of the inventory and equipment lost in the fire, you ask your accountant for copies and hand them over.

* Later, your insurer offers to settle the claim for an amount far less than your loss. In fact, the insurer's offer doesn't come close, and you go into a slow burn, muttering that you need to spend your time getting back into business, not fighting with some insurance company.

What's wrong here? Is your insurer trying to shortchange you?

Probably not. Whatever the suspicions of their critics, insurers don't make it a practice to cheat their customers on claims.

In all likelihood, the better bet is that you erred in handing your tax returns to the adjuster in the first place--because your returns probably don't reflect the real value of your inventory and equipment, much less the insured value.

For one thing, your tax returns value your inventory as of the end of your tax year, not the day before your fire. (The returns of people who fudge don't show even that value.)

For another, your returns probably show the depreciated value of your equipment, not the cost of replacing it. (Tax law allows you to take a deduction against income for depreciation--on the theory that equipment wears out over time, and that the smart business owner saves up to replace it. So if you bought your equipment 10 years ago, your tax returns value it far below your original purchase price, much less the cost of replacing it now.)

What all this boils down to is that:

* In the event of a fire, your tax returns give your insurer an inaccurate picture of the value of your inventory and equipment, and

* If you hand over your returns when disaster destroys your paper records, you give your insurer an opportunity to make you angry.

The better idea is to keep your returns to yourself and establish the value of your lost property by other means--for example, by asking your accountant for your most recent financial statements, or your suppliers and customers for copies of invoices and purchase orders.

This can take time, according to Ken Esserman, a public insurance adjuster for Metropolitan Adjustment Bureau Inc. in Encino, but it can save you some grief if your insurer tries to hold you to the figures on your tax returns.

It also helps, Esserman adds, to understand what kind of insurance you carry--replacement cost coverage or actual cash value coverage.

Replacement cost coverage pays you for the cost of replacing inventory and equipment destroyed in your fire. If the fire ruins a printing press that cost you $1 million 10 years ago, your insurer must pay you whatever you spend to replace the press with like equipment, even if the new press costs you $2 million.

Put another way, depreciation doesn't matter with replacement cost coverage, and your tax returns have no bearing on settling the claim, Esserman says. So long as you replace the lost equipment, your insurer must cover the cost.

On the other hand, cash value coverage pays you for the actual cash value of the lost items, which usually means replacement cost less depreciation. If you have depreciated that $1-million press to $250,000, and the replacement press costs $2 million, you get only $1.25 million from your insurer--replacement cost less depreciation.

As Esserman notes, replacement cost insurance and cash value insurance are two different kettles of fish, and if you have a fire, you may well wish you had the former, not the latter. In either case, you want to give your insurer no excuse to settle your claim for anything less than what your policy entitles you to, he says.

That means keeping your tax returns out of the hands of the insurance company's adjuster unless you have no other means of establishing your loss.

"Claims often put you in an adversary position with your insurance company," Esserman says. "You have to give your insurer information needed to settle the claim--and nothing else. You want to be very precise and not confuse anybody and do exactly what you need to do to establish the claim.

"But tax returns are privileged communications between you and the government," he adds. "They may contain lots of other information that doesn't pertain to the claim."

*

Columnist Juan Hovey can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net.

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