In the initial rush to pass the Tax Cuts & Jobs Act (TCJA), taxpayers and practitioners were left with implementation questions regarding many provisions.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act and subsequent guidance clarified some of those questions but also raised new ones, and we still aren’t clear with respect to Paycheck Protection Program (PPP) loan forgiveness and the deductibility of the related expenses.
As we near the end of 2020, here are some considerations that restaurant operators, in particular, should take into account while doing their year-end tax planning.
Bonus depreciation for QIP
The technical glitch that caused much heartburn for operators was finally fixed in the CARES Act. An error in the TCJA did not allow bonus depreciation to be applied to qualified improvement property (QIP) placed in service after Jan. 1, 2018. QIP generally includes any improvement to the interior of a nonresidential building if the improvement is placed in service after the building was placed in service. It generally excludes enlargement of the building and improvements to elevators, escalators, and internal structural framework.
Following the passage of the CARES Act, QIP placed in service in 2018 and later years now qualifies for 100% bonus depreciation through 2022, as does QIP acquired after Sept. 27, 2017, and placed in service in 2017. In addition, the depreciable life for such property is now 15 years and not 39 years.
What if you filed your 2018 and 2019 returns not claiming 100% on QIP? To catch up the bonus depreciation that was originally missed, you can potentially amend the 2018 or 2019 returns, or you can file an IRS Form 3115 (“Application for Change in Accounting Method”) in your 2019 or 2020 return. Learn more.
Net operating losses
The above benefit can also play into another of the CARES Act changes, which allows for 100% of net operating losses (NOLs) incurred in tax years beginning after Dec. 31, 2017, and before Jan. 1, 2021, to be carried back to the prior five tax years. Additionally, NOLs incurred in 2018, 2019, and 2020 that are not carried back can be carried forward to fully offset income in tax years beginning before 2021. The prior TCJA limit of 80% goes away, at least temporarily. Beginning in 2021, TCJA NOLs – including those generated in 2018-2020 – can only offset 80% of income if carried forward.
This utilization of NOLs is important, and taxpayers should do a calculation to determine if it is more tax-efficient to carry such NOLs back or forward (i.e., if the tax rate in earlier years was higher than current tax rates).
Excess business losses
The TCJA included a new excess business loss limitation, which limited the ability of taxpayers to claim business losses in excess of business income, plus $250,000 for single and $500,000 for married taxpayers.
The CARES Act suspended this loss limitation rule until 2021. Taxpayers that applied such limitation to their 2018 or 2019 returns must amend those returns to fully utilize such losses.
It should be noted that the proposed Heroes Act would curtail some of the CARES Act enhancement related to NOLs and excess business losses. Specifically, it would allow 2019 and 2020 NOL carrybacks, but only to 2018, and it would bring back the TCJA limitation on business losses. Additionally, a change in administration could also result in significant tax law changes. This uncertainty should motivate taxpayers to file their 2019 returns and any amended or carryback claims as soon as possible.
Section 163(j) business interest limitation
Internal Revenue Code (IRC) Section 163(j) limits the amount of interest expense certain taxpayers can deduct in a year. The original law limited the deduction of interest to 30% of adjusted taxable income (ATI) for the year for certain taxpayers considered tax shelters or with average annual gross receipts for the prior three years over $25 million (for 2019, $26 million). The CARES Act modified this rule for corporations (i.e., not partnerships) in 2019 and increased the limit to 50% of ATI. The Act provides other taxpayer-friendly elections that can be made. Any taxpayer subject to these rules should review their 2018 and 2019 tax return to determine if the changes will benefit them.
PPP loan forgiveness
The PPP came in under the CARES Act to assist businesses during the pandemic. The initial rules issued by the Treasury and Small Business Administration (SBA) were vague and generated more questions than answers. (Visit our Coronavirus Resource Center for PPP overviews, updates, and guidance.)
The intent of this program was to provide struggling businesses with a loan that would be forgiven if used for qualified purposes and if certain salary and hiring requirements were met. This forgiven loan is not deemed taxable income; but can borrowers deduct the expenses paid with such loan proceeds?
We believe the intent was that such expenses would be allowable business deductions, hence creating a true non-taxable loan. But the IRS has stated that because the income is not taxable, the expenses paid with such proceeds are NOT deductible, resulting in an unintended tax consequence for the borrower.
While we were all are hoping for guidance or clarification from Congress or the Treasury on this issue as year-end tax planning has commenced, it is doubtful any clarity will be available anytime soon. So, taxpayers are left with the law as it stands, and if loan forgiveness is received then such related expenses may not be deductible. This will be an unwelcome surprise to many operators. As they have struggled through the pandemic and are losing money, they may potentially have an unexpected tax liability.
The PPP loan forgiveness rules also were substantially modified as part of the Paycheck Protection Program Flexibility Act (PPPFA) to be more taxpayer-friendly. As many operators will recall, the initial covered period was only eight weeks. For many restaurants, this period was insufficient to utilize all the PPP funds received as many states were still in lockdown mode. The revision allowed businesses to choose either an eight- or 24-week covered period. Taxpayers then have 10 months to apply for forgiveness once the covered period ends.
Another taxpayer-friendly change was to the requirement that at least 75% of the forgivable amount come from qualified payroll costs. The PPPFA reduced this to 60%.
The question many operators have asked is whether they should apply for forgiveness PRIOR TO the end of their covered period. It would appear that if an operator has utilized all its PPP funds and, based on their computation of forgiveness, has achieved 100% forgiveness, then there would be no reason to wait. But there are complexities to this computation, and one must do a calculation to determine if early loan forgiveness filing makes sense. CohnReznick can help with that determination.
Accounting method changes
Small taxpayers (below an average gross receipt for the prior three years of $26 million) can potentially access certain benefits by filing an “Application for Change in Accounting Method,” IRS Form 3115. These potential benefits include use of the cash method of accounting, exemption from the uniform capitalization rules, and, important for restaurants, the ability to treat inventories as nonincidental materials and supplies.
Two important hospitality-related credits did not change in 2020. The first is the Federal Insurance Contributions Act (FICA) tip credit, a federal tax credit related to the FICA taxes paid by the employer on declared employee tips. The second is the Work Opportunity Tax Credit, a significant but often overlooked federal tax credit related to hiring certain types of qualified employees, such as veterans, people receiving government assistance, and former felons.
State conformity and credits
You should review how your state conforms to the TCJA and CARES Act changes and availability of any state-specific credits.
For example, California does not conform to federal bonus depreciation or the NOL rules discussed above. But, currently, the state does follow the federal treatment on forgiveness of PPP loans and the non-deductibility of the related expenses.
California also recently enacted a new hire tax credit equal to $1,000 for each net increase in qualified employees up to $100,000 total for each qualified small business employer. This credit is only available for taxable years beginning on or after Jan. 1, 2020, and before Jan. 1, 2021. A qualified business is one that:
1. As of Dec. 31, 2019, employed 100 or fewer employees.
2. Has a 50% decrease in gross receipts by comparing gross receipts for the 3-month period beginning April 1, 2020, and ending June 30, 2020, with the gross receipts for the 3-month period beginning April 1, 2019, and ending June 30, 2019.
A qualified business does not include a taxpayer required or authorized to be included in a combined report.
There are other requirements, and most importantly, to qualify, the taxpayer MUST submit an application with the California Department of Tax and Fee Administration (CDTFA) for a tentative credit reservation between Dec. 1, 2020, and Jan. 15, 2021.
These are just a few items to consider when doing year-end planning that could save your business money during this difficult time.
- Tax Credits
- Paycheck Protection Program (PPP) Loan Forgiveness Assistance
- PPP Loan Forgiveness Solutions for Lenders
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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