Not only is the end of the year reserved for holidays and time with family, it is also the time of year for year-end tax planning. Although there have been few changes in tax law for the 2023 tax year, there are still numerous strategies that can be implemented to help reduce tax liabilities heading into year-end:
For many years, most assets with the exception of real property such as leasehold improvements, equipment, and fixtures could be immediately expensed for income tax purposes through bonus depreciation. Starting with the 2023 tax year, 80% of this cost is eligible to be immediately expensed with the remaining depreciated over its useful life. The 2024 tax year will be another “phase-down” year of bonus depreciation where only 60% of the cost can be immediately expensed. Although this is a timing difference, accelerating capital expenditures into 2023 can provide immediate tax and cash-flow benefits. In addition, cost segregation studies should be explored for new builds and refreshes of existing locations to explore accelerated depreciation options.
Pass Through Entity Taxes
2023 saw several additions to the list of states enabling pass-through entity tax elections (PTET), as well as clarifications to already existing programs. In short, the PTET election allows an entity to pay state tax on income that would have previously been passed through and paid at the individual shareholder/partner level. This tax paid at the entity level is then considered an expense of the entity for tax purposes, reducing Federal income that is passed on to the member. The tax payment retains characterization as a distribution for book purposes, similar to any composite payment made.
Each state’s program functions slightly differently, and the complex set of rules around what payments require addbacks or allow credits create additional compliance but ultimately can provide a large Federal benefit for owners. Ahead of any fourth-quarter payments, it is key to consider whether inclusion in a PTET filing makes sense at the entity level.
Interest Expense Limitations
Originally imposed through the Tax Cuts and Jobs Act of 2017, code section 163(j) imposed an interest expense limitation for many businesses. Currently, interest expense for a business could be limited if the interest expense exceeded 30% of tax-based EBIT. In a rising interest rate environment and change of the limitation formula from tax-based EBITDA, many more companies are finding themselves subject to the interest expense limits. Proper year-end planning will be key to plan for and potentially avoid any limitations.
Potential Tip Credit Elimination
Driven by increasing pressure to increase wages, many state legislatures have begun proposals to increase state level minimum wages which could eliminate the tip credit. Although this is still being legislated in many states, all operators should keep a close eye on legislation in each state they operate to evaluate the impact the elimination of the tip credit would have on their business.
The Work Opportunity Tax Credit (“WOTC”) and Empowerment Zone Credits (“EZ”) are wage based credits for employees which meet certain criteria (i.e. residence, food stamp recipients, veteran, and ex-felons to name a few). The amount is driven on the amount of wages paid to eligible employees and is set to expire on December 31, 2025. You must have a process in place to screen eligible employees before claiming the credit. If you are not claiming the credits, consider evaluating the credit as it can yield significant credit amounts in high-turnover businesses such as restaurants.
Start Planning for Known Law Changes
Many favorable tax provisions such as the Qualified Business Income (“QBI”) deduction and decreased individual income tax rates are scheduled to expire on December 31, 2025. Although this is two years away, owners should begin considering these law changes when evaluating capital expenditures, exit transactions, or any other tax strategy which has an opportunity to defer the recognition of expense or accelerate the recognition of income. Being proactive in managing known changes in tax law can manage significant benefits in the long term.
Research and Development Costs and Tax Credit
Beginning with the 2022 tax year, all taxpayers including restaurants were required to capitalize any expenditures related to research and development. The capitalized expenditure is then amortized over a period of five years. For restaurants, examples of research and development costs could include: menu development, app development, and implementation of customized ERP systems. Although the capitalization requirement is not tax favorable, this does highlight the opportunity for restaurants to claim a tax credit for research and development activities. This can be a lucrative credit offered at the federal and some state levels and should be evaluated in conjunction with the new capitalization requirement.
Tax planning is essential for businesses looking to optimize cash flow while minimizing their total tax liability over the long term. Contact your GBQ engagement team or Ryan Kilpatrick to discuss any of these year-end tax-saving strategies.