The Tax Cuts and Jobs Act - Key Considerations for your Restaurant Business for 2018
With the passage of the Tax Cuts and Jobs Act (“the Act”) on December 22, 2017, taxpayers are scrambling to evaluate how the Act impacts their overall tax position. By this point, many taxpayers are aware that changes are coming, but are still working to identify and prioritize what they need to do to best position themselves as we head into 2018.
To help you navigate through the Act and identify how best to maximize potential benefits – or minimize potential costs – arising from the Act, we thought it would be helpful to summarize what has changed, what has not changed, and what you should be considering as you look at the impact the Act could have on your restaurant business.
WHAT HASN’T CHANGED?
Work Opportunity Tax Credit (WOTC)
This beneficial, and often ignored, federal credit is for the hiring of certain classes of employees (low income, students, veterans, ex-cons). Previous WOTC provisions remain unchanged under the new tax law.
FICA Tip Credit
This federal credit is for employer FICA taxes paid on tips to your employees. There is no change to this credit under the new tax law.
WHAT’S NEW . . . LOTS OF THINGS!
Historically, this provision allowed for the immediate expensing of 50% of the cost of certain qualified property. The Act has significantly increased the benefits of this provision. Taxpayers are now able to deduct the entire cost of qualified assets that are acquired and placed in service after September 27, 2017. If you, however, had a binding contract in place for property prior to September 28, 2017, that date will be considered the acquisition date for this purpose and your bonus deprecation on such assets will be based on the prior law. Qualified assets include short-lived assets (i.e., furniture, fixtures, and equipment) as well as Qualified Improvement Property (QIP). QIP is any improvement to the interior portion of a non-residential building, if the improvement is placed in service after the date the building was first placed in service. QIP does not include improvements which are attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building. While not 100% clear, because of how the new law was drafted, there is uncertainty around the ability to take bonus on QIP acquired and placed in service after September 27, 2017 and before December 31, 2017.
Important Note for Restaurateurs: Review fixed asset and leasehold improvement additions to determine what qualifies for bonus. Consider a cost segregation study on significant build outs.
Qualified Improvement Property
While it is unclear whether companies can take bonus depreciation on QIP acquired and placed in service after September 27, 2017 and before December 31, 2017, it is clear that – without a technical correction – the new law would not allow bonus depreciation on QIP placed in service on or after January 1, 2018. In the Conference Report that accompanied the new law, Congress clearly stated its intent that QIP be eligible for bonus depreciation and that it would have a 15-year recovery period. However, because of the way the law was written, this is not the case. We will update you as to any changes with respect to QIP.
Important Note for Restaurateurs: The Act expanded the type of property eligible for bonus depreciation to now include used property; historically, only “new” property was eligible. The used property must fit within one of the categories of qualified property and must be acquired and placed in service on or after September 28, 2017. The used property must not be property that was previously owned by the taxpayer and cannot be acquired from a related party.
Section 179 Deduction
The Act increased the expense limitation to $1,000,000 (from $500,000) for additions for qualified assets placed in service after December 31, 2017. Additionally, the phase-out of this benefit does not begin to occur until there are $2,500,000 (historically the phase-out began at $2,000,000) of qualifying additions. The Act also broadened qualified property to now include certain real property, including roofs, HVAC, fire, alarm, and security systems.
All individual tax brackets were reduced, with the highest rate – that for individuals filing jointly – decreasing from 39.6% to 37% once income is over $600,000. Similarly, the corporate income tax rate was reduced to 21% from 35%.
Pass-Through Entity Deduction
A new 20% deduction for taxpayers with income from S corporations, partnerships/LLCs, and sole proprietorships was created. The deduction is equal to the lesser of 20% of Qualified Business Income (QBI) or a limitation based on the greater of the two tests below:
a) 50% of the taxpayer’s pro-rata share of W-2 wages paid by the entity; or
b) the sum of 25% of the W-2 wages with respect to the business, plus 2.5% of the basis of all qualified property.
The W-2 and/or asset tests above would not apply if the taxpayer’s taxable income was below the threshold amounts set forth in the Act ($315,000 for taxpayers filing a joint return; $157,500 for single filers) and would be phased in (apply to a limited extent) if the taxpayer’s taxable income was between $315,000 and $415,000 (joint filers - $157,500 - $207,500 for single filers). Note that these thresholds are based on taxable income, not QBI.
Taxpayers that receive income from personal service businesses generally may not take advantage of the 20% deduction unless the taxpayer’s taxable income is under the abovementioned threshold amounts. The deduction phases out for joint filers (with business income from personal services) between $315,000 and $415,000 (single filers $157,500 - $207,500). For purposes of this provision, service businesses include businesses that “involve” professional service companies, such as lawyers, accountants, doctors, consultants, etc. It is not clear under the Act whether the provision of a relatively small amount of services would make a business a “service” business. As of the date of this document, there is no guidance from the IRS as to whether a business could be bifurcated into service and non-service businesses to take advantage of the rule. The list of services included in this rule is long and there are exceptions. Please contact us with any questions you have.
Important Note for Restaurateurs: Evaluate entity level W-2 wages and basis of qualified property to assure no limitation on the potential 20% deduction is imposed.
Limit on Deduction of Business Interest
For tax years beginning after December 31, 2017, there is a new limitation on the amount of interest expense that a taxpayer may be able to deduct. Essentially, a taxpayer’s interest expense will be limited to 30% of the entity’s adjusted taxable income (ATI). ATI is taxable income before deduction for interest expense, depreciation, amortization or depletion, any net operating loss deduction, or interest income – any interest expense above that amount is “disallowed” as a deduction in the current year. Any disallowed interest is carried over as business interest to the succeeding tax year. For partnerships and LLCs, this limitation is computed at the entity level, and any allowed deduction is part of each partner’s non-separately stated taxable income or loss.
Note that an exemption to the business interest limitation applies to taxpayers, other than tax shelters, with average annual gross receipts for the three-year period ending with the prior tax year, not exceeding twenty-five million. There is also an election out of this provision for real property trades or businesses (but this exemption would likely not apply to a restaurant). So – this interest expense limitation will not apply to restaurants with income below the twenty-five million threshold, but restaurants with receipts exceeding twenty-five million should be certain to structure their affairs to take this interest limitation into account. For purposes of the twenty-five million threshold, taxpayers would need to aggregate revenue from related entities. The aggregation rules are very complicated. Please contact us if you have specific questions.
Important Note for Restaurateurs: A portion of current expense currently would not be deductible. Consider current debt levels and if debt restructuring is beneficial.
With respect to “small taxpayers,” the limitations in section 448 (relating to the use of the cash method of accounting) have been modified so that taxpayers with annual average gross receipts under $25 million (historically
under $5 million) will be permitted to use the cash method of accounting. Additionally, small taxpayers will no longer be required to apply the uniform capitalization (UNICAP) rules, which will simplify your future tax filings.
Meals and Entertainment Expenses
For tax years beginning after December 31, 2017, while the cost of business meals will still be deductible as they were before, no deduction will be allowed for entertainment, amusement, or recreation activities. Accordingly, going forward, taxpayers will need to identify non-deductible entertainment activities, and will continue to identify business meal expenses subject to the 50% limitation. However, the 50% limitation on the deductibility of meals will now include meals provided via an in-house cafeteria or otherwise on the premises of the employer.
Important Note for Restaurateurs: Evaluate the impact of this provision to employer-provided meals, including pre-shift and post-shift meals.
Stay tuned – while not necessarily the law today, we expect many states to decouple from the Bonus Deprecation, Section 179, and “flow-through entity” deductions and perhaps other Act provisions.
SO – WHAT’S NEXT FOR YOU?
The changes summarized above (and other changes not discussed), raise a number of questions, opportunities, and challenges to restaurant owners: How should I structure my business? Should I change my entity from a pass-through entity to a corporation or vice-versa? Should I immediately deduct all of my fixed asset purchases prospectively (regardless of my entity type)?
Historically, choosing the type of entity to hold a restaurant was a fairly straightforward, although a bit cumbersome, process. The changes discussed above, including the 20% deduction for “flow-through” businesses and the expansion of bonus depreciation, may make new entity selection a complicated process. Keep in mind that one should not rush to the conclusion that forming a C corporation is more beneficial than forming a pass-through entity, as the “double tax trap” still exists, and there are other considerations – including exit strategy and timing, impact on financing flexibility, and ownership structuring, and potentially estate planning could all impact what is right for you.
Also – and these points should not be overlooked – many changes on the individual side, such as increases in the standard deduction, the limit on deducting state income and property taxes to $10,000, and the increase in the alternative minimum tax exemption amounts, may also play into the entity selection process.
We would be remiss if we focused only on tax considerations relating to the Act. Restaurant owners should also be aware of new state and local law changes effective January 1, 2018 relevant to the industry. For example, changes to minimum wage, paid parental leave, scheduling restrictions, workplace sanctuary, and employee favorable salary and criminal history provisions (such as the ban the box provision in California) may impact your onboarding process and how you operate your restaurant.
Finally, although the individual mandate of the Affordable Care Act (ACA) was repealed, the ACA provisions still apply at the employer level if the business has 50 or more full-time equivalents, and the IRS has announced its intent to audit employer’s compliance with the ACA. Be aware that simply utilizing your payroll service's ACA module does not assure you are in compliance. We recommend having a tax or human resources professional review your 1094-Cs and 1095-Cs for possible errors.
What Does CohnReznick Think?
Wow! This was a brief overview of things we think you should know. Clearly, there are a lot moving parts and things for you to consider. In summary, there will be winners and losers under the Act, and it seems the advertised simplification of the new tax law may not have been necessarily achieved – at least for business owners. As noted, the complexity of these provisions should be carefully analyzed, and we believe that the items listed above present a useful starting point for restaurant owners and operators as they work to understand how the Act impacts them.
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 specific to, among other things, your individual facts, circumstances and jurisdiction. 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 partners, 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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A collection of insights on the impact of the Tax Cuts and Jobs Act