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Year-End Tax Planning: What You Need to Know Now


While tax planning is a year-long task, the end of the calendar year presents an opportunity to review tax strategies implemented in the past, as well as prepare for potential tax legislation that could significantly impact a restaurant business. Short of Congress passing tax legislation, taxpayers are left to make business decisions without knowing whether or not significant tax provisions (which expired on December 31, 2013) will be extended before year-end. However, understanding the potential developments with regard to new or existing tax laws will caution taxpayers to areas that are no longer allowed under the law and assist business owners in maximizing tax savings. Below are key tax provisions that CohnReznick believes that restaurant operators should consider:

Incentives for Investment in Property and Expansion of a Business

Certain states may not conform to the provisions regarding investment in property and expansion of a business. For example, California has different Section 179 thresholds. With respect to unclaimed property and gift cards, approximately 32 states have favorable rules. New York, in particular, will escheat unclaimed gift cards.
  • The 2013 bonus depreciation provisions for qualified new property additions – allowing for immediate 50% depreciation on qualified asset purchases placed in service prior to January 1, 2014 expired. These provisions also applied to certain qualified leasehold improvement property. 
  • The enhanced Section 179 expensing provisions, which provided for a current deduction of up to $500,000 on qualifying new or used property placed in service prior to January 1, 2014, is also no longer effective. This deduction will decrease to a maximum $25,000 annual deduction.  This deduction is phased out once overall qualified asset purchases are $225,000. The failure to extend these two provisions would significantly increase the out-of-pocket cost for an operator with respect to 2014 build outs. In addition, this could pose an issue for fiscal year pass-through entities with 2014 year-ends. Even though 2013 purchases would be subject to the higher limits, the pass-through of these items to a calendar year (2014) shareholder would be subject to the lower limits causing a loss of deductions.
  • A 15-year depreciation life was allowed for certain qualified leasehold improvements, qualified restaurant property, and qualified retail improvements placed in service prior to January 1, 2014. Absent an extension of this provision, the depreciation life for non-residential real estate is 39 years.
  • Note that Congress may retroactively modify the depreciation regulations discussed above and is also debating reinstating bonus depreciation and Section 179 rules.


Repair and Capitalization Regulations

State enterprise zones, such as the federal empowerment zones, provide tax incentives at the state level for businesses that operate in certain qualified areas. Of note, California repealed its Enterprise Zone credit program as of December 31, 2013 and replaced it with the new GO-Biz/ California Competes credit program. The new program is somewhat similar to the old program, though not as beneficial and contains a major exclusion impacting the restaurant industry. Certain food services companies are excluded from qualifying for this new program unless they meet the small business exception. Similarly, New York is offering incentives such as the Excelsior and Start-UP NY programs.

  • The IRS released final “repair regulations” in September 2013. These complicated regulations provide guidance on when taxpayers are required to capitalize certain costs and when they can currently deduct costs for acquiring, maintaining, repairing, and replacing certain property.  These regulations apply to tax years beginning on or after January 1, 2014, though can be applied to the 2012 and 2013 tax years. Any taxpayer that owns tangible property, especially building owners, should address the new requirement to file IRS Form 3115 (Application for Change in Accounting Method) adopting the new unit of property (UOP) definition. This requirement is applicable to tax years beginning on or after January 1, 2014. The IRS expects every taxpayer to adopt the new tangible property regulations by filing a Form 3115. 


The safe harbor de minimus expensing rule – a provision that is generally taxpayer-friendly – requires action prior to the 2014 year end. This rule provides that a taxpayer with audited financials can currently deduct the cost of up to $5,000 per invoice or per item of new property additions ($500 if the taxpayer does not have audited financials). To take advantage of this safe harbor provision for the 2015 tax year, the taxpayer must have in place by prior to January 1, 2015 a “written accounting” policy treating such costs below the threshold as a current deduction and must account for such items in accordance with this policy. To benefit from this provision for 2014, the policy should have been in place prior to January 1, 2014.


Tax Credits

  • The research and development credit can provide up to a 20% credit for certain qualified expenses incurred for the development of new products, methodologies, procedures, or technologies over a certain base amount. This credit expired at the end of 2013. Though not normally considered an industry utilizing this credit, there are circumstances where restaurant operators could be considered to have incurred qualifying expenditures (i.e. test kitchens, development of new yeast strains, or technology).
  • The work opportunity tax credit provides a generous credit for the hiring of certain qualified individuals who begin work prior to January 1, 2014. To date, however, it has not been extended. Such qualified individuals include employees receiving certain government benefits, supplemental social security income, or long-term family assistance, as well as veterans. Advanced certification is required to claim this credit, and documentation is needed on or prior to the day the employee begins work. It is a rolling credit that can provide benefit in years subsequent to the year of hire.
  • The FICA tip credit is provided to operators based on employee tips for which social security has been paid. Though this credit is not set to expire, it is oftentimes overlooked in the industry.


Other Tax Provisions That May Impact Your Restaurant Business             

Gift cards are a significant part of many restaurant businesses. Understanding and complying with gift card escheat rules is important, and each state has different rules regarding gift cards. For example, in California, gift cards never expire so no funds are required to escheat to the state. However, if the business has operations in states where gift cards expire and escheat rules apply, establishing a separate gift card entity to minimize or eliminate turning over those funds to the state may be a consideration. In California, gift cards with a value under $10 are redeemable for cash if requested by the holder. Failure to comply with this law has subjected many California operators to class action suits.

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Some states may consider mandatory tips or service charges as part of the sale of food and subject these amounts to sales tax.  For instance, California treats mandatory tips as part of the sale of the meal and subjects the tips to sales tax. New York treats mandatory tips similarly, in which the tip has to be noted as a gratuity or tip – not a service charge (which  is taxable).

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Some restaurants now charge customers “reservation or no show fees”. Are such fees subject to sales tax?  An informal letter from the California State Board of Equalization has stated that such fees are not  subject to sales tax if the customer does not show up for their reservation. If a customer uses the reservation, then the fee is considered received as part of the transfer of a tangible product (the meal) and subject to sales tax. In New York, this area does not pose a significant issue and no regulations currently exist.

  • Recently, the IRS issued guidance on allocation of costs to produce food pursuant to IRC section 263A (capitalization of certain indirect costs of property produced and held in inventory). This guidance, along with comments by IRS personnel, indicates an increased focus on applying IRC section 263A to restaurants. For many restaurant owners, the tax implications of IRC section 263A are minimal, as raw food inventory at year-end is either insignificant or is not stored for an extended period of time. For other restaurant owners – for example, those maintaining large and expensive liquor inventories – the issue may be more relevant. In light of the IRS’ increased interest in this area, operators should evaluate their tax exposure to IRC Section 263A.

    Implementation of the Affordable Care Act (Obama Care) provisions  have been delayed until 2015 for employers with 100 or more full-time employees, and until 2016 for those with 50 or more full-time employees. It is still unknown whether the 30-hour-per-week threshold will be increased to 40 hours, or whether the Act itself will be repealed.
     
  • In 2014, mandatory tips are not considered tips for purposes of IRS Form 8027 or Form 8846 FICA tip credit. These amounts will need to be treated as wages to the server and will not be eligible for the FICA tip credit, even if they are distributed to the server similar to a normal tip. For such a tip to not be considered a mandatory service charge, it must be made free from compulsion, the customer must have unrestricted right to determine the amount, the payment should not be the subject of negotiation or dictated by employer policy and generally, and the customer has the right to determine who receives the payment. An operator may instead want to provide a suggested tip schedule on the bill and allow the customer to determine the actual tip, thus avoiding this provision.

 

What Does CohnReznick Think?

With competition from other concepts, increasing food and labor costs, and local and federal tax rates on the rise, restaurant operators should proactively seek to maximize the bottom line. Many of the points listed above can provide significant savings without altering the culture of a restaurant. Devoting time to address some of these items prior to year-end can result in monetary savings.

CohnReznick advises that Congress may act on tax provisions in the future, causing changes to the tax treatment of certain items. CohnReznick will release new information in this regard as it becomes available.

Contact

For more information, please contact Gary Levy, partner and Hospitality Industry Practice Leader, at gary.levy@cohnreznick.com or 646-254-7403, and Marshall Varano, partner, at marshall.varano@cohnrenick.com  or 858-300-3424. To learn more about CohnReznick’s Hospitality Industry Practice, visit our webpage.


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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