Year-end tax planning for restaurants

The restaurant industry is a field filled with many opportunities to save money on corporate taxes. A majority of these tax deductions do not require significant time and can provide a lot of benefits to your business. Here are a few things to consider.

Depreciation

First, let’s look at a deduction related to accelerated depreciation expenses. Restaurants are consistently having to replace furniture and kitchen equipment, or refreshing the aesthetics of the establishment. All these improvements are capital expenditures that are required to be capitalized and depreciated over their useful life. Section 179 of the tax code allows businesses to deduct the full purchase price of qualifying equipment that is purchased during the tax year if the capitalized cost provided doesn’t exceed certain thresholds. Section 179 cannot make the taxable income negative and for 2023 you are limited to the first $1,160,000 of expenditures so long as the overall capital expenditures do not exceed $2,890,000.

Even though all capital expenditures that are placed in service are depreciable, the accelerated depreciation methods are not available to real property (i.e. buildings, parking lots, etc.). If your establishment purchased a building, we recommend considering a cost segregation analysis to determine if a portion of the costs are eligible under the accelerated depreciation methods.

An alternative for accelerated depreciation is to use Section 168 which is commonly referred to as “Bonus Depreciation”. Section 168 may apply if the business is at a loss, it has over $2,890,000 in capital expenditures, or if there are certain types of trusts and IRA’s that are owners of the entity (as certain types of trusts and IRA’s cannot receive the immediate benefit of Section 179). In 2023, this provision allows companies to deduct 80% of the qualified capital expenditures immediately and the other 20% over their useful life. Historically, this allowed 100% deduction, but that practice is being phased out. The accelerated deduction is 80% of the costs in 2023, 60% in 2024, 40% in 2025, 20% in 2026 and zero starting in 2027. The portion not deducted under Section 168 will be depreciated over its useful life using a modified accelerated cost recovery system (MACRS).

Another factor to consider when discussing depreciation is if it makes sense to claim either §179 or §168 as described above, or if it makes more sense to opt out of them. If your business will be at a loss with or without the accelerated depreciation provisions, then you will need to consider when and how those losses will be utilized. If depreciating under §179 or §168 will be increasing a Net Operating Loss (NOL) and there is taxable income projected in the near future, then the business may consider performing an additional analysis on when taxable income is expected and if it’s better to have the larger NOL carried forward or have the depreciation deductions preserved for those future periods. This is because NOL’s are currently limited to 80% of taxable income going forward.

The last area in depreciation to review is how the repair regulations are being applied. Many restaurants capitalize repairs as they extend the useful life of the assets. Under the current rules, if the repair is not a major component or critical with respect to the overall asset, considered routine maintenance or a major component to the building system, then the business could potentially deduct the full amount for income tax purposes. A detailed review helps identify these opportunities.

Tax credits

A second area with several opportunities is the tax credits available to restaurants. The Federal Insurance Contributions Act (FICA) Tip credit is a large opportunity for food and beverage establishments. This credit is calculated based on the FICA taxes that the business pays for any income in excess of the minimum wages. The minimum wage for this calculation was set at $5.15 per hour when the credit was created and has not been increased for purposes of this calculation.

The Work Opportunity Tax Credit (WOTC) can also provide benefits to businesses if they are hiring people in one of the targeted groups of job seekers who have consistently faced barriers to employment. This credit requires more effort than some of the others, as the business will have to report on each employee that qualifies in order to be able to claim the credit. However, if your business hires a large portion of people in one of the targeted groups, then the benefit could be well worth the effort. Some of the common targeted groups include veterans, ex-felons, and long-term unemployment recipients.

For companies that are passthrough entities for income tax purposes (partnerships or S corporations), restaurants should be adding footnotes to their K-1’s to allow shareholders to claim the Qualified Business Income deduction. This will allow shareholders to potentially reduce their effective tax liability by up to 20% (taking the tax rate from 37% to 29.6%).

There are numerous ways to structure entities in the restaurant industry and each structure has its own pros and cons. It is important to continuously discuss the structure of the business along with the exit plan with your trusted tax advisors to ensure that the business is set up in the most advantageous manner. Your business structure will help determine which of the above-mentioned ideas are best for your company and may open other opportunities to review.

Whether you are looking at depreciation or tax credits or other ways to maximize tax savings, restaurant owners and operators need to stay up to date with the ever-changing tax environment.

For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.