Article written by:
Hannah Henderson, CPA, Tax Senior
Without a doubt, 2020 will go down in history as being one of the most challenging and uncertain years for many restaurants, with COVID-19 related restrictions and closures, labor shortages and capacity limits. Fortunately, several pieces of legislation have come out this year providing relief, clarification of guidance and new opportunities to generate additional cash flow to restaurant operators. As we reach the end of 2020, below are key items to consider when restaurants think about year-end planning tax strategies.
Qualified Improvement Property (QIP) Technical Correction
With the passing of The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Congress addressed the much anticipated “restaurant/retail glitch” associated with the 2017 Tax Cuts and Jobs Act (TCJA). The TCJA previously prevented investments in QIP from qualifying for bonus depreciation. 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. Within the CARES Act, the recovery period for QIP is reduced from 39 years to 15 years, making it eligible for 100% bonus depreciation through 2022. This change is retroactive to January 1, 2018, forward. Thus, it creates an opportunity to increase depreciation deductions and reduce taxable income. If you already filed your 2018 and 2019 returns not taking advantage of this, you can catch up on this deduction by either amending those returns or by filing an IRS Form 3115 (“Application for Change in Accounting Method”) on your 2020 tax return. If this change increases a loss for 2018, 2019 or 2020, this will be of value related to the new loss carryback provisions mentioned below.
Net Operating Loss (NOL) Provisions
The above depreciation benefit can also play into another piece of the CARES Act changes, which allows for 100% of net operating losses (NOLs) incurred in tax years 2018, 2019 and 2020 to be carried back to the prior five tax years. Prior to this change, losses from 2018 onward could only be carried forward. The losses can be applied against income from the previous five years, thus creating tax refund opportunities and increased cash flow. Additionally, NOLs incurred in 2018, 2019 and 2020 not carried back can be carried forward. The prior TCJA NOL 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.
Lifting of Excess Business Loss
The TCJA included a new excess business loss limitation, which limited the ability of taxpayers to claim business losses in excess of business income. Any business losses in excess of $250,000 for a single taxpayer and $500,000 for married taxpayers were limited. The CARES Act suspended this loss limitation rule until 2021. Taxpayers who applied this limitation to their 2018 or 2019 returns should amend those returns to fully utilize such losses. This is important as it provides another opportunity for restaurateurs to generate additional cash flow by receiving tax refunds from those prior years.
As a reminder, two important 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 federal tax credit related to hiring certain types of qualified employees, such as veterans, people receiving government assistance, and former felons.
New in 2020 is the Employee Retention Credit (ERC). This credit is only available for taxpayers who did not receive a Paycheck Protection Program loan. The ERC is a fully refundable credit against the employer’s 6.2% share of Social Security taxes for businesses that, (a) are forced to fully or partially close their operations, or (b) remained open, but during any quarter in 2020, gross receipts were less than 50% of what they were for the same quarter in 2019. The credit is available for qualified wages paid by qualified employers from March 13, 2020 through December 31, 2020. For employers with 100 or fewer employees, qualified wages include all wages paid during the qualified quarter. For employers with more than 100 employees, only wages paid while the employee was not working are qualified. The tax credit is equal to 50% of qualified wages paid to each employee for the quarter and is limited to $5,000 per employee ($10,000 in eligible wages times 50%).
Paycheck Protection Program (PPP) Tax Implications
On November 18, 2020, the Treasury and the IRS released much anticipated guidance on the tax treatment and timing of certain expenses incurred related to loans obtained in connection with the PPP that was part of the CARES Act. While the CARES Act excluded the forgiveness of such loans from taxable income, there were no provisions that addressed the deductibility of expenses paid with the loan proceeds.
The IRS previously issued Notice 2020-32, which concluded that taxpayers may not claim a deduction for otherwise deductible business expenses that were generated by the use of PPP loan proceeds in respect of forgiven PPP loans. The basis for this conclusion is related to long-standing tax law and precedents related to expenses allocable to classes of tax-exempt income and the treatment of reimbursed expenses.
Since the issuance of that guidance, taxpayers have been left with a degree of uncertainty as to the recognition timing of such nondeductible expenses. Specifically, how the timing of filing forgiveness applications, and ultimately having loans approved or denied for forgiveness, would impact expenses paid or incurred in 2020. Rev. Rul. 2020-27 clarified these timing issues and affirmed the IRS’s position that expenses related to the use of PPP loan proceeds are nondeductible. In both examples provided in Rev. Rul. 2020-27, the IRS ruled that if the taxpayer “reasonably expects” to receive forgiveness on these otherwise deductible expenses, those expenses are nondeductible on their 2020 income tax returns. These examples affirm the position of the IRS that the timing of the forgiveness does not ultimately delay the expenses from being nondeductible in 2020. This could largely affect restaurants with significant PPP loans, as these addbacks can create or increase taxable income.
Other Planning Considerations
Restaurant operators should consider all of the above-mentioned items and how they can be combined together to maximize potential tax deductions and credits to create cash flow.
In addition to QIP mentioned above, other opportunities do exist for bonus depreciation. Many assets, including machinery, equipment, and furniture will qualify for bonus depreciation and can be 100% expensed in 2020.
Taxpayers should also not forget about state tax issues. Many states do not conform to bonus depreciation rules and thus deductions taken on the federal return may not also be taken on the state returns, increasing taxable income for that state. Not all states conform to all provisions of the TCJA either. Any other changes and availability of state-specific credits should also be reviewed during 2020 tax planning.
There were many changes in 2020. While questions remain, you can count on GBQ to keep up. For further details on the key items for tax planning noted above, reach out to your GBQ tax advisor or visit our COVID-19 Resources Page.