Our government rolled out the Coronavirus Aid, Relief and Economic Security Act (CARES Act) incredibly quickly to deal with the burgeoning socio-economic issues caused by the global pandemic. This post will just outline a few of the restaurant tax provisions contained in the new law.
TCJA amended Section 163(j) to greatly expand limitations to the deductibility of restaurant interest. Essentially, if you conducted business (whether in one entity or many entities related through common ownership) and had gross revenues in excess of 25 million ($26 million in 2019, adjusted for inflation), you were limited to 30% of your “adjusted taxable income” with respect to your interest deduction. Adjusted taxable income is your taxable income with interest expense and interest income added back as well as your depreciation (although the depreciation add-back phased out in a few years). The CARES Act temporarily increases the limitation to 50% of adjusted taxable income. There are some different applications of the rules with respect to partnerships passing out these limitations.
Qualified Improvement Property: When the Tax Cuts and Jobs Act (TCJA) was passed late in 2017 (another rush job), there was a poorly drafted section which attempted to simplify the multiple definitions of leasehold improvements by combining all such definitions into one category called Qualified Improvement Property (QIP). It was intended that this property would be 15 years MACRS property and as such would be entitled to bonus depreciation (as long as bonus was available). The poorly drafted legislation, however, ended up classifying such property as 39 year property and thus unavailable for bonus depreciation. There has been significant pressure on Congress to fix this “glitch” but as commentators are suggesting, it took a global pandemic to get this done. The CARES “fixes” the glitch by assuming that the TCJA had been “correctly” drafted. What we do not know is how do taxpayers fix this. Can you use a Change in Accounting Method form 3115 and reflect the catch up change all in 2019 or do you need to go back and amend 2017 and/or 2018 returns? In some cases, certain decisions may have been made that would not have been made had TJCA been initially drafted correctly. For example, a restaurant might have made an election to be treated as a real property trade or business in order to escape the Section 163(j) interest limitation rules. Another example may have been where a restaurant expensed such QIP under Section 179 which could have negatively impacted passive investors in that business who might not have had the type of income to utilize Section 179 expenses.
We are already scrambling to redo some 2019 returns we have completed to take advantage of both this rule and the relaxation of the Section 163(j) limitation.
Where the QIP fix could come into play is the CARES Act changed the rules regarding Net Operating Loss (NOL) usage. Since TCJA, NOLs could only be carried forward and could only offset 80% of your income. With the passage of the CARES Act, NOLs can now be utilized against 100% of your income and, perhaps more importantly for cash strapped taxpayers, can be carried back for up to 5 years to obtain refunds of prior year taxes paid. Of course, it cannot be just that simple, so NOLs allowed for the 5 year carryback must originate in 2018, 2019 or 2020 and the 100% allowance only applies until 2021. Query: What restaurants will have taxable in 2020 or 2021, for that matter? Another question: if you are carrying losses back, do you have to go back 5 years or what are the mechanics?
Under TCJA, an individual with an “excess business loss” was limited to $250,000 to offset income including wages ($500,000 for MFJ). This is suspended for 2018, 2019 and 2020, although other limitations still apply (e.g., passive loss rules, basis limitations, etc.). Beginning in 2021, the limitation comes back but wages will not count (not good).
All in all, there is a lot here to not only help restaurants (and individuals conducting businesses through flow through entities) to retain cash that would have gone to taxes but also to possibly get refunds of prior year taxes. As with any tax-related post, there are always many exceptions, nuances, and “it depends” so nothing is straightforward and, as such, use this as a starting point to your education.
Bradley Dimond, CPA