By Russ Frederick and Gary Boteler, Partners at Carr, Riggs & Ingram
It is a near certainty as of this date that substantial tax reform will likely be passed into law and effective for years beginning in 2018. In connection to the expected tax reform, year-end tax planning for restaurant owners is subject to a good bit of uncertainty at the moment. In general, it seems the best advice...
It is a near certainty as of this date that substantial tax reform will likely be passed into law and effective for years beginning in 2018. In connection to the expected tax reform, year-end tax planning for restaurant owners is subject to a good bit of uncertainty at the moment. In general, it seems the best advice...
for now is to defer income and accelerate deductions when possible. Due to the nature of the restaurant industry, there are not many options available to defer income however, depending on the size of the restaurant operations and accounting method (accrual or modified cash basis) being utilized by the restaurant owner, there may be opportunities to accelerate certain deductions for expenditures such as the accelerated payment or accrual of year-end bonus’, if actually paid by accrual base taxpayers within 3 ½ months after year end. The balance sheet should be reviewed and close examination given to certain areas. For example, prepaid expenses for items such as insurance, licenses and service contracts should be written down if the opportunity exists to do so, based on the terms of the underlying contract or other circumstances associated with the prepaid item. Review activity relating to fixed assets and consider the appropriate classification of current year additions as repairs and maintenance vs. capitalization. Receivables do arise on occasion in restaurant operations in connection with catering/customer, employee or vendors activities and if they are deemed uncollectible write them off in 2017. Terms and conditions associated with receipts from the sale of gift cards and certain vendor incentive advances should be examined and deferred from income where appropriate and allowed. If your retirement plans allows, consider making or increasing deductible employer contributions to the plan. Plan to utilize any available carryforward losses and credits. Owners of S-Corporations and Partnerships that have current year or past suspended losses due to basis limitations should consider restoring basis in order to utilize the losses, especially if the losses would offset other sources of taxable income.
Although is it getting late into the year and not much time remains to make significant decisions, any year-end tax planning by restaurant owners should certainly consider an evaluation of key elements included in the proposed tax reform. Details from the joint congressional committee are beginning to emerge now and indications are that congress expects to have a bill for the President to sign before Christmas. For example, would it be better to purchase and place into service an equipment package now, or defer that decision until next year? Should I hire someone that might be qualified for the Work Opportunity Tax Credit now or should I defer that hire until next year? These decisions might depend on the tax landscape that might be in place in years beyond 2017. It’s been since 1986 that the winds of tax change have potentially blown this powerfully. Both the House and Senate have passed versions of tax reform, and the next step in the process is for members from both houses of Congress to develop a compromise final tax reform bill. This bill must then pass both houses of Congress and be signed by President Trump into law to create the final Tax Cuts and Jobs Act of 2017 (TCJA). To understand where a compromise tax bill may ultimately fall, we’re going to look at where these two tax reform bills are similar and where they diverge and how this might impact your tax planning for 2017and future years.
Key Business Provisions Where Both Bills Agree
Corporate Tax Rates. The House and Senate bills permanently reduce the current maximum corporate rate from 35% to 20%. Details emerged from the joint conference committee on Wednesday the 13th that both chambers have settled on a 21% maximum corporate rate, effective beginning in 2018. If your profitable restaurant is organized as a “C-corporation”, the proposed tax reform will likely result in reduced taxes owed and those tax reductions may be substantial in future years depending on the amount of taxable income generated by your business.
Depreciation. Both bills allow businesses to fully and immediately expense 100% of the cost of certain qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023.
Like-Kind Exchanges. Both bills repeal the ability for companies to defer taxes related to trade-in of like-kind personal property. The only like-kind exchanges that would remain would be those involving real estate. While it might not be very common for restaurants to exchange items of personal property, it is fairly common in the restaurant industry to consider the exchange of highly appreciated real property. If the circumstances to exchange are present, this can be a very valuable method to defer substantial capital gain taxes and it is an important win for the industry that it appears likely that this tax benefit will remain intact.
Net Operating Losses (NOLs). Per both bills, restaurant owners could no longer carryback their NOLs. Instead, they could carry them forward and offset a portion of future income. The carryover deduction to future years under both bills will be limited to 90% of pre-net operating loss income.
Interest Expense. While the exact calculation differs between the two bills, both bills limit the amount of interest expense that companies could currently deduct.
Please note that while these bills agree on some of the over-arching concepts above, there are still subtle differences in these provisions. For example, the corporate tax rate in both bills is reduced to 20%, but the House bill makes that effective in 2018 while the Senate bill makes that rate first effective in 2019. Therefore, even when these bills seem to “agree”, there may still be specifics that the joint committee will need to potentially improve before they spring into action.
Major Differences in Business Provisions in the House and Senate Bills
Pass-Through Entity Tax Rates. Currently, owners of pass-through entities such as “S-corporations” and “Partnerships” pay tax on their pass through net incomes at ordinary income tax rates. Both bills aim to reduce the tax rates on certain types of pass-through income, although the methods of doing so vary greatly:
House Bill: Subjects a portion of certain pass-through income to a maximum rate of 25%, with the balance still subject to the ordinary income tax rates. It also adopts a new 9% tax rate on the first $75,000 (or $37,500 for single filers) in net business income passed through to an active owner earning less than $150,000 (or $75,000 for singles) in taxable income.
Senate Bill: Creates a 23% deduction on certain specified pass-through income. Salaries paid to pass-through owners and partners would still be taxed at ordinary income tax rates. The Senate bill also imposes other rules that would prevent pass-through owners from trying to re-characterize their salaries into pass-through profits.
Depreciation and Section 179. As mentioned above, while bills allow businesses to fully expense 100% of the cost of qualified property, the definitions of that qualified property and the allowed depreciation timing differs under the two bills. Differences also exist for the popular Section 179 deduction under both bills as follows:
House Bill: Allows expensing of used property but excludes property used in a real estate business. The House provision allowing full expensing expires in 2023. Additionally, under Code Section 179, the House bill allows for immediate expensing of most new and used property (excluding structures) up to $5 million and the dollar limit for assets placed in service is increased to $20 million. The $5 million Section 179 is phased out on a dollar-for-dollar basis for assets placed in service above this $20 million amount. Also, the House bill retains a 39 year depreciable life for non-residential buildings.
Senate Bill: Delivers exactly the opposite – it does not allow expensing of used property but does allow expensing of property used in a real estate business. The Senate bill begins phasing it out in 2023, but it reduces the deduction 20 percentage points each year for four years and then sunsets it completely for the fifth year. Additionally, under Code Section 179, the Senate bill allows for immediate expensing of most new and used property (excluding structures) up to $1 million and the dollar limit for assets placed in service and is increased to $2.5 million. The $1 million Section 179 is phased out on a dollar-for-dollar basis for assets placed in service above this amount. Also, the Senate bill reduces the depreciable life for most buildings to 25 years and that could be a substantial reduction (from current tax law of 39 years) for restaurant owners that are planning to place buildings into service.
FICA Credit. The Senate bill retains, without modification, the popular credit known as the FICA tip credit for restaurant owners that pay FICA taxes on the tipped wages of employees. The House bill proposes to modify this credit by removing reference to the 2007 federal minimum wage rate of $5.15 per hour, and replacing that longtime frozen rate with the current monthly minimum wage rate to be in place during future tax years. That rate is currently $7.25 per hour. By way of calculating the credit, restaurant owners can expect a reduced credit in future years if the House version of the bill is approved into law. The House bill also contains a provision that states that the FICA tip credit will not be available to any taxpayer that does not comply with the informational tip reporting requirements included on form 8027. Additionally, the established minimum guidance of reporting tips (used by the IRS to gauge compliance of restaurant employees with tip reporting to their employer) of at least 8% of gross receipts has been increased to 10% in the House version of the bill.
Corporate Alternative Minimum Tax (AMT). The House bill repeals the corporate AMT while the Senate bill retains it. Details emerged from the joint conference committee on Wednesday the 13th that the Senate has also agreed to repeal the corporate AMT.
Work Opportunity Tax Credit (WOTC). The House bill repeals this tax credit entirely, while the Senate version retains it for companies hiring certain types of individuals.
We believe these items outlined above in the current proposed tax reform will have the most impact on restaurant owners. Consideration should be given now to these items and an assessment made on how they might impact your overall business. Lobbying by special interest groups is intense, and there are still significant negotiations that must take place to arrive at a single bill that will garner enough support to pass. As noted above, it seems to be a certainty that big tax law changes are coming for next year and those changes should generally result in lower taxes for both businesses and individuals, however, details of those changes could be significantly different from the items discussed above.
Although is it getting late into the year and not much time remains to make significant decisions, any year-end tax planning by restaurant owners should certainly consider an evaluation of key elements included in the proposed tax reform. Details from the joint congressional committee are beginning to emerge now and indications are that congress expects to have a bill for the President to sign before Christmas. For example, would it be better to purchase and place into service an equipment package now, or defer that decision until next year? Should I hire someone that might be qualified for the Work Opportunity Tax Credit now or should I defer that hire until next year? These decisions might depend on the tax landscape that might be in place in years beyond 2017. It’s been since 1986 that the winds of tax change have potentially blown this powerfully. Both the House and Senate have passed versions of tax reform, and the next step in the process is for members from both houses of Congress to develop a compromise final tax reform bill. This bill must then pass both houses of Congress and be signed by President Trump into law to create the final Tax Cuts and Jobs Act of 2017 (TCJA). To understand where a compromise tax bill may ultimately fall, we’re going to look at where these two tax reform bills are similar and where they diverge and how this might impact your tax planning for 2017and future years.
Key Business Provisions Where Both Bills Agree
Corporate Tax Rates. The House and Senate bills permanently reduce the current maximum corporate rate from 35% to 20%. Details emerged from the joint conference committee on Wednesday the 13th that both chambers have settled on a 21% maximum corporate rate, effective beginning in 2018. If your profitable restaurant is organized as a “C-corporation”, the proposed tax reform will likely result in reduced taxes owed and those tax reductions may be substantial in future years depending on the amount of taxable income generated by your business.
Depreciation. Both bills allow businesses to fully and immediately expense 100% of the cost of certain qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023.
Like-Kind Exchanges. Both bills repeal the ability for companies to defer taxes related to trade-in of like-kind personal property. The only like-kind exchanges that would remain would be those involving real estate. While it might not be very common for restaurants to exchange items of personal property, it is fairly common in the restaurant industry to consider the exchange of highly appreciated real property. If the circumstances to exchange are present, this can be a very valuable method to defer substantial capital gain taxes and it is an important win for the industry that it appears likely that this tax benefit will remain intact.
Net Operating Losses (NOLs). Per both bills, restaurant owners could no longer carryback their NOLs. Instead, they could carry them forward and offset a portion of future income. The carryover deduction to future years under both bills will be limited to 90% of pre-net operating loss income.
Interest Expense. While the exact calculation differs between the two bills, both bills limit the amount of interest expense that companies could currently deduct.
Please note that while these bills agree on some of the over-arching concepts above, there are still subtle differences in these provisions. For example, the corporate tax rate in both bills is reduced to 20%, but the House bill makes that effective in 2018 while the Senate bill makes that rate first effective in 2019. Therefore, even when these bills seem to “agree”, there may still be specifics that the joint committee will need to potentially improve before they spring into action.
Major Differences in Business Provisions in the House and Senate Bills
Pass-Through Entity Tax Rates. Currently, owners of pass-through entities such as “S-corporations” and “Partnerships” pay tax on their pass through net incomes at ordinary income tax rates. Both bills aim to reduce the tax rates on certain types of pass-through income, although the methods of doing so vary greatly:
House Bill: Subjects a portion of certain pass-through income to a maximum rate of 25%, with the balance still subject to the ordinary income tax rates. It also adopts a new 9% tax rate on the first $75,000 (or $37,500 for single filers) in net business income passed through to an active owner earning less than $150,000 (or $75,000 for singles) in taxable income.
Senate Bill: Creates a 23% deduction on certain specified pass-through income. Salaries paid to pass-through owners and partners would still be taxed at ordinary income tax rates. The Senate bill also imposes other rules that would prevent pass-through owners from trying to re-characterize their salaries into pass-through profits.
Depreciation and Section 179. As mentioned above, while bills allow businesses to fully expense 100% of the cost of qualified property, the definitions of that qualified property and the allowed depreciation timing differs under the two bills. Differences also exist for the popular Section 179 deduction under both bills as follows:
House Bill: Allows expensing of used property but excludes property used in a real estate business. The House provision allowing full expensing expires in 2023. Additionally, under Code Section 179, the House bill allows for immediate expensing of most new and used property (excluding structures) up to $5 million and the dollar limit for assets placed in service is increased to $20 million. The $5 million Section 179 is phased out on a dollar-for-dollar basis for assets placed in service above this $20 million amount. Also, the House bill retains a 39 year depreciable life for non-residential buildings.
Senate Bill: Delivers exactly the opposite – it does not allow expensing of used property but does allow expensing of property used in a real estate business. The Senate bill begins phasing it out in 2023, but it reduces the deduction 20 percentage points each year for four years and then sunsets it completely for the fifth year. Additionally, under Code Section 179, the Senate bill allows for immediate expensing of most new and used property (excluding structures) up to $1 million and the dollar limit for assets placed in service and is increased to $2.5 million. The $1 million Section 179 is phased out on a dollar-for-dollar basis for assets placed in service above this amount. Also, the Senate bill reduces the depreciable life for most buildings to 25 years and that could be a substantial reduction (from current tax law of 39 years) for restaurant owners that are planning to place buildings into service.
FICA Credit. The Senate bill retains, without modification, the popular credit known as the FICA tip credit for restaurant owners that pay FICA taxes on the tipped wages of employees. The House bill proposes to modify this credit by removing reference to the 2007 federal minimum wage rate of $5.15 per hour, and replacing that longtime frozen rate with the current monthly minimum wage rate to be in place during future tax years. That rate is currently $7.25 per hour. By way of calculating the credit, restaurant owners can expect a reduced credit in future years if the House version of the bill is approved into law. The House bill also contains a provision that states that the FICA tip credit will not be available to any taxpayer that does not comply with the informational tip reporting requirements included on form 8027. Additionally, the established minimum guidance of reporting tips (used by the IRS to gauge compliance of restaurant employees with tip reporting to their employer) of at least 8% of gross receipts has been increased to 10% in the House version of the bill.
Corporate Alternative Minimum Tax (AMT). The House bill repeals the corporate AMT while the Senate bill retains it. Details emerged from the joint conference committee on Wednesday the 13th that the Senate has also agreed to repeal the corporate AMT.
Work Opportunity Tax Credit (WOTC). The House bill repeals this tax credit entirely, while the Senate version retains it for companies hiring certain types of individuals.
We believe these items outlined above in the current proposed tax reform will have the most impact on restaurant owners. Consideration should be given now to these items and an assessment made on how they might impact your overall business. Lobbying by special interest groups is intense, and there are still significant negotiations that must take place to arrive at a single bill that will garner enough support to pass. As noted above, it seems to be a certainty that big tax law changes are coming for next year and those changes should generally result in lower taxes for both businesses and individuals, however, details of those changes could be significantly different from the items discussed above.
