Year-end tax planning opportunities for the hospitality industry

This year, 2022, will be the last year taxpayers can utilize the 100% bonus depreciation provision for fixed assets and qualified improvement property (QIP). As we have mentioned in prior year-end tax planning articles, QIP includes 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. 

For assets placed in service in 2023 through Dec. 31, 2026, the bonus depreciation rate goes down to 80% and then phases out 20% per year until it gets to zero in 2027.

This means operators considering asset purchases or interior upgrades should consider placing such assets in service prior to Dec. 31, 2022, to utilize the current 100% bonus depreciation benefit.

The significant COVID-19 tax benefit related to net operating losses (NOLs) has also been reduced.

Post-Dec. 31, 2017, through Dec. 31, 2020, NOLs still enjoy a five-year carryback and indefinite carryforward period. However, any of these NOLs utilized in tax years beginning after Dec. 31, 2020, may only offset up to 80% of taxable income after utilizing any remaining pre-Jan. 1, 2018, NOLs.

Additionally, use of any post-Dec. 31, 2020, NOLs generated cannot be carried back and are subject to the 80% of taxable income limitation mentioned above when carried forward. Taxpayers should be aware of this limitation in determining any NOL carryforwards into 2022 and confirm they carried back any NOL’s for the year’s election to forego NOL carryback was not made.

Businesses may wish to inquire if your state conforms to these new federal NOL rules. California, for example, enacted its own NOL rules which originally suspended use of NOLs for tax years between 2020-2022 if your net business income or modified adjusted income was $1 million or more. On Feb. 9, 2022, California Governor Gavin Newsom signed AB 113, which provided some relief and removed the NOL suspension for the 2022 taxable year.

The Tax Cuts and Jobs Act of 2017 (TCJA) included a new excess business loss limitation, which limited the ability of taxpayers to claim business losses in excess of business income, plus $270,000 for single and $540,000 for married taxpayers for 2022. The CARES Act repealed this loss limitation rule until 2021. Taxpayers that applied such limitation to their 2018 or 2019 returns can amend those returns to fully utilize such losses.

Taxpayers may check their 2021 individual tax returns to confirm that the excess business loss limitation rules were applied correctly as well as consider this rule when performing 2022 year-end planning. Operators who may have generated large losses from their restaurants may not realize as much of a benefit as they thought from these losses.

IRC section 163(j) limits the amount of interest expense certain taxpayers can deduct in a year. The law, as originally written, 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 $26 million for 2021 ($27 million for 2022). Operators should check that they have complied with these rules, especially since the calculation of ATI also changed.

The Paycheck Protection Program (PPP) ended in 2021 and guidance was finally provided stating that taxpayers could deduct the expenses paid with PPP funds even if the PPP loans were forgiven in part or in full.

Businesses may wish to confirm state conformity with the federal rule. For example, California does not conform completely. AB 80 provides that the PPP expenses paid with forgiven loan funds are only deductible if the business had at least a 25% decline in gross revenue for any quarter of 2020 as compared to 2019. Additionally, you may also want to confirm that PPP loan forgiveness income was properly treated as tax-exempt income for shareholder/partner tax basis purposes. It’s also important to note that the AB exception discussed above does not apply to publicly traded companies.

Small taxpayers below an average gross receipt for the prior three years’ $26 million threshold for 2021 and $27 million threshold for 2022, can access certain benefits by filing an Application for Change in Accounting Method, IRS Form 3115. These 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.

The Employee Retention Credit (ERC) was a significant benefit for most hospitality companies. This COVID-19 era credit provided qualified employers with a refundable tax credit for wages paid to employees in 2020 and 2021.

The qualification rules can be complex, but most hospitality clients should qualify for the tax credit and if they have not claimed the credit yet, can still file amended Forms 941X to do so.

It is important to note that the IRS is reviewing these ERC claims closely due to the many “pop up” ERC shops who did not apply the rules correctly. One important item to remember is that any wages used in your PPP forgiveness application or for other wage related credits (i.e., Work Opportunity Tax Credit) cannot also be used to claim the ERC (i.e., no double dipping). Also, taxpayer’s must reduce their wage expense deduction on their returns by the amount of ERC claimed for federal purposes pursuant to IRC 280C (check your state for conformity).

Two other important hospitality related tax credits did not change. The first is the Federal Insurance Contribution 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.

On Aug. 16, 2022, the President signed the Inflation Reduction Act with most of its provisions providing benefits related to clean energy. The main benefits, to personal and nonrenewable energy businesses, relate to expanded and increased tax credits for certain qualified “clean vehicles” and an increase in the residential and commercial solar energy credit from 26% to 30% for installations between 2022-2032.

There has been much talk around the new corporate minimum tax provision, but, since this provision only impacts large companies with annual average net book income of $1 billion, it most likely will not impact many hospitality clients.

Establishing a gift card company (Giftco) in a favorable jurisdiction in order to minimize the risk of having to escheat unredeemed/unexercised gift cards/certificates for unclaimed property compliance purposes should be considered. To this end, unclaimed property has become an important area of concern for many businesses, especially in the hospitality industry. That is, companies are wrestling with unclaimed property issues related to unredeemed gift certificates/cards, including the timing for remitting the unclaimed property, the amount to escheat, the jurisdiction to which funds must be remitted, and the associated record-keeping requirements in order to be in compliance with states’ reporting obligations.

A planning opportunity exists whereby a specific purpose entity is formed in a favorable jurisdiction, which does not escheat unexercised gift cards/gift certificates. There are roughly 32 states that have favorable unclaimed property rules that would need to be analyzed to assure optimum benefits are realized, both from an unclaimed property as well as from a tax perspective.

In general, the gift card management strategy would involve forming Giftco in one of the favorable jurisdictions and then transferring unexercised gift certificates/cards into the newly form entity, thus allowing the transferor the potential to avoid having these items become escheatable, provided they are transferred prior to the expiration of the dormancy period on such property. In addition, all future sales of gift cards/certificates by Giftco would be governed by the unclaimed property rules in state in which Giftco was formed, thereby minimizing prospective unclaimed property tax liabilities and compliance burdens.

As mentioned above you should review how your state conforms to these tax opportunities and changes, and availability of any state specific tax credits. These are just a few items to consider when doing year-end tax planning that could save your hospitality business money during today’s challenging times.