Every business should have adequate insurance coverage in the event of fire, flood or other natural disasters. Similarly, you may have “business interruption insurance” to compensate the company for lost profits while you’re closed.

Hopefully, you won’t need to collect on those policies. But it’s better to be safe than sorry.

Advice: Consider the tax implications of business insurance. You might want to adjust your policies—or secure new ones—to ensure that you maximize the tax benefits.

The basics: Insurance proceeds that compensate your business for lost income are generally treated as income subject to tax. “Lost income” may include compensation for services already provided by the business, as well as profits that were anticipated but never realized.

On the other hand, the IRS exempts some insurance proceeds from tax. Under a special provision in the tax code—Section 1033—you can avoid paying taxes on insurance proceeds received because of property damage by reinvesting in replacement property. For this purpose, “property damage” includes theft, seizure and condemnation.

Pay close attention to the fine print in your policies to strengthen your tax position. Remember that it’s better taxwise to have proceeds characterized as “replacement property” rather than “payment attributable to profits.”

Here are a few helpful hints for obtaining the best tax results:

• The policies should specifically provide “loss of value” coverage to the extent that your business assets may lose value.

• The policy should pay benefits on a flat per-diem basis, without any mention of profits or fixed-business charges if you insure additional potential losses. The per-diem amount can be adjusted for inflation.

• The policies should not refer to historic profits or be limited by those profits in any way.

If you follow these suggestions, you may avoid having your insurance proceeds re-cast as income. That way, you will have the full proceeds to reinvest in replacement assets.