Top Ten Tax Planning Items for Restaurants in 2018
The end of the year is fast approaching, and by now most of the provisions from the tax reform bill have gone into effect. So, what does this mean for your restaurant business? It means that it’s time to start tax planning!
Tax reform brought about many changes and opportunities for planning; we’ve handpicked ten changes that are especially beneficial to the restaurant industry.
1. Pass-Through Tax Treatment/Section 199A
Effective for taxable years beginning after December 31, 2017, a new deduction of 20 percent of “qualified business income” from partnerships, S corporations and sole proprietorships is available. This new deduction will be taken at the owner level. Some limitations do exist, but most restaurants are generally expected to qualify for the full 20 percent deduction.
Planning opportunities and observations for the 199A deduction include:
- Reducing S corporation owner compensation, which can result in:
- Employment tax savings for the business.
- A higher 199A qualified business income deduction for the owner.
- Reduction in owner’s federal income tax liability.
- Note that owners must still receive reasonable compensation for services performed.
- LLC owners may be able to similarly reduce their federal tax liability and increase their qualified business income deduction by receiving preferred returns in lieu of guaranteed payments.
2. Depreciation & Section 179
Under the new law, an additional first-year depreciation deduction of 100 percent is allowed for certain assets acquired after September 27, 2017, and placed in service between September 28, 2017, and December 31, 2022. The 100-percent bonus deduction begins phasing down in 2023. There are no limitations on the amount of bonus depreciation that can be taken, and bonus depreciation can cause a business to have a taxable loss. Taxpayers may elect out of bonus depreciation, which can be a good planning tool to spread-out deductions evenly throughout future years.
Property that qualifies for 100-percent bonus depreciation includes:
- Tangible property depreciated under modified accelerated cost recovery system (MACRS) that has a recovery period of 20 years or less, such as restaurant equipment, restaurant furniture and land improvements. As of now, Qualified Improvement Property (QIP) does not have a recovery period of 20 years or less, and therefore does not qualify for 100-percent bonus depreciation (see additional discussion below).
- The property can be new or used (this is new, under previous law used property did not qualify for bonus).
Restaurants are likely familiar with the controversy surrounding QIP. QIP is an improvement to the interior of a restaurant that is made after the building is first placed into service. One of the more significant changes included in tax reform was to combine the two previous 15-year life categories of Qualified Restaurant Property and Qualified Leasehold Improvement Property into one category, QIP.
However, in what appears to be an inadvertent oversight, QIP was neither designated as 15-year property nor as a specific category of asset eligible for bonus depreciation. Without either of these designations, until such time as technical corrections are issued, QIP must be depreciated over 39 years (and therefore is not eligible for bonus depreciation).
The following changes to Section 179 have been made for taxable years beginning after December 31, 2017:
- The maximum amount a taxpayer may expense has been increased to $1,000,000.
- The phase-out threshold amount has been increased to $2,500,000.
- Changes qualified real property (if elected) to include:
- QIP (covers interior improvements to existing buildings).
- Certain exterior improvements to existing buildings including roofs, HVAC, fire protection and alarm and security systems.
Depreciation and Section 179 planning opportunities and observations include:
- Cost segregation studies on new construction are now more valuable than ever.
- Moving 39-year life assets to shorter life classifications that are available to take advantage of 100 percent bonus may be more beneficial.
- Finally moving forward on the remodels you have been delaying.
- 100-percent bonus on short-life assets (and possibly all interior improvements if technical corrections issued) may be available.
- Larger deductions are available for companies able to take advantage of Section 179 and bonus depreciation.
- Restaurants that previously could include qualified restaurant property as Section 179 property are now limited to QIP and limited exterior improvements only.
- Evaluating the use of Section 179 versus bonus depreciation (or the election out of).
3. Net Operating losses
For losses arising in tax years beginning after December 31, 2017, net operating loss deductions will be limited to 80 percent of taxable income (determined without regard to the deduction). In addition, losses generated after December 31, 2017, can only be carried forward.
NOL planning opportunities include:
- Due to the 80 percent limitation on the use of net operating losses, taxpayers that generate significant losses in one tax year may end up with taxable income in the next year, resulting in an unexpected cash need to pay the resulting tax liability. Examples of managing this include electing out of bonus depreciation in years of large capital expenditures, or delaying some deductions into the following tax year so that losses span over a period of time versus all in one tax year.
4. Business Losses
Business losses for individuals (including K-1 losses from flow-through entities) are now only permitted in the current year to the extent that they do not exceed the sum of:
- Taxpayer’s gross income and;
- $500,000 for joint filers or $250,000 for other taxpayers.
Consider the same planning ideas mentioned for NOLs when planning and budgeting yearly expenditures for your pass-through entities.
5. Corporate Income Tax Rates
The maximum corporate tax rate has been permanently reduced from 35 percent to a flat tax rate of 21 percent. Of course, this rate cut will reduce the tax burden for most restaurateurs structured as C corporations. Restaurants can now redeploy the tax savings from this rate reduction to other areas such as expansions, remodels or compensation adjustments.
6. Corporate Alternative Minimum Tax (AMT)
The corporate AMT was repealed effective for tax years beginning after December 31, 2017. Going forward, any AMT credit carryovers may be used to offset the regular tax liability for any taxable year after 2017. In addition, AMT credits generated in prior years are refundable for any taxable year beginning after 2017 and before 2022 in an amount equal to 50 percent (100 percent for taxable years beginning in 2021) of the excess credit for the taxable year. These changes could result in lower taxes or possibly a refund for restaurants organized as a corporation.
7. Interest Expense Deductions
Beginning after December 31, 2017, the deduction for business interest expense is limited to the sum of business interest income plus 30 percent of the adjusted taxable income of the taxpayer for the taxable year. Interest expense that is disallowed during the tax year can be carried forward indefinitely. This carryforward is a tax attribute that carries over in the hands of individual taxpayers in the case of pass-through entities.
Planning opportunities and observations for interest expense deductions include:
- The limitation on deductibility is not applicable to taxpayers with average annual gross receipts for the three-taxable-year period ending with the prior taxable year that do not exceed $25 million.
- Taxpayers who are using debt to fund new restaurant openings and incurring significant start-up expenses could find themselves deferring the interest expense deduction as a result of lower taxable income.
8. Like-Kind Exchanges
The new law limits the non-recognition of gain for like-kind exchanges that occur after December 31, 2017, to real property that is not held primarily for sale. Keep this in mind when planning as like-kind exchange tax deferral treatment for items such as vehicles, artwork and jewelry will no longer be available.
9. Tax Credits
In terms of tax credits, if you are not currently taking the Work Opportunity Tax Credit (WOTC), consider checking your eligibility to see how much credit may be available to you. Restaurants may also want to consider the FICA tip credit for servers and delivery drivers.
- Tax credit available for employers hiring individuals from one or more of 10 targeted groups of employees.
- Credit is based on the amount of qualified wages earned by employees in their first two years of employment.
- Credit is available for employees hired prior to January 1, 2020.
FICA Tip Credit
- Tax credit available for employers to reimburse them for the social security and Medicare taxes paid on employee reported tips over $5.15 per hour.
10. Entertainment & Meal Expenses
Entertainment expenses paid or incurred after December 31, 2017, are no longer allowed to be deducted unless those amounts are included in employee’s income. This means no deductions for entertainment activities, recreation activities, facilities or membership dues related to such activities.
The 50 percent deduction for food and beverage expenses associated with operating a trade or business has been retained. Deductions for meals provided on or near employee’s premises for convenience of the employer are reduced from 100 percent to 50 percent (through December 31, 2025) and then will be non-deductible starting January 1, 2026. There is currently no guidance issued regarding the deductibility of shift meals provided by restaurants.
Keep these changes in mind when budgeting and planning business expenses, as they will affect taxable income.
Next Steps for Restaurants
With the variety of recent changes to the tax code, be sure to incorporate the applicable planning items in your yearly tax planning to save your restaurant and individual owners some tax dollars. For example, try running taxable income projections using different scenarios to get the most favorable outcome, such as taking bonus depreciation versus electing out of bonus depreciation. Of course, having planning conversations with a tax advisor can always help ensure the best possible tax outcome.
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