Hospitality companies are regularly required to renew franchise agreements and liquor licenses. These renewals can result in significant cash outlays. Additional locations may be opened as part of a long-term expansion program resulting in significant pre-opening costs for staff training, technology, promotional costs, utilities, bedding, bath towels, etc. A careful examination of the tax consequences is required to more efficiently use the tax benefits from these transactions.
The tax treatment of franchise renewal fees is fairly straightforward and is addressed by Internal Revenue Code (IRC) Section 197(f)(4)(B), which says the costs for renewing a franchise shall be treated as an acquisition. Furthermore, any costs paid or incurred for the issuance—or earlier renewal—continue to be taken into account over the remaining portion of the amortization period that began at the time of the issuance or earlier renewal under Treasury Regulations §1.197-2(f)(4). This means the cost to renew a franchise is amortized over a 15-year time period that begins with the month of the renewal. In addition, no write-off of the unamortized cost of the issuance or earlier renewal is allowed at the time of the subsequent renewal. This can be particularly frustrating in situations where the franchisor requires a renewal of the franchise before the 15-year amortization period has expired on the issuance or earlier renewal of the franchise.
Renewals of liquor licenses issued by governmental agencies are treated slightly different than franchise renewal fees. A 15-year amortization period is generally required for these types of licenses as a “§197 intangible” under IRC §197(d)(1)(d). However, a shorter amortization period may be allowed if the license is acquired in the ordinary course of a trade or business and not part of the acquisition of assets constituting a trade or business and if the license has a duration of less than 15 years. In these situations, the renewal costs are amortized over the term of the license. Note that, similar to franchise renewals, the hospitality company renewing a liquor license that had a term of less than 15 years that was acquired as part of the acquisition of the business will not be able to write off the unamortized costs of the initial liquor license upon its renewal. The unamortized costs of the original issuance will continue to be taken into account over the remaining portion of the amortization period that began at the time of the issuance.
Taxpayers running successful hospitality business enterprises may also look to expand operations and add locations. Generally speaking, under IRC §195, taxpayers are required to capitalize amounts paid or incurred in creating an active trade or business. Alternately, taxpayers may be allowed a deduction for start-up costs up to $5,000, reduced dollar-for-dollar (but not below zero) by the cumulative start-up costs exceeding $50,000. Any remaining start-up costs are then amortized over a 15-year period starting in the year that the active trade or business begins. There has been much controversy relating to determining when a trade or business begins. A careful distinction also must be made between start-up and expansion costs for an existing business. Expansion costs for an existing business or new location are generally deductible when incurred.
Lastly, hospitality companies should be cognizant of various federal tax credits available to assist hospitality operators in meeting their federal income tax obligations.
The Work Opportunity Tax Credit program offers employers federal income tax credits to hire individuals of certain targeted groups, including:
- Members of families receiving benefits under the Temporary Assistance to Needy Families (TANF) program
- Qualified veterans
- Qualified ex-felons
- Designated community residents
- Vocational rehabilitation referrals
- Qualified summer youth employees
- Qualified Supplemental Nutrition Assistance Program (SNAP) recipients
- Qualified Supplemental Security Income (SSI) recipients
- Long-term family assistance recipients
- Long-term unemployed individuals
The credit for hiring an individual of a targeted group can range from $1,200 to $9,600 depending on the targeted group and the amount of wages paid.
The Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips also is available to hospitality companies. This is a potentially lucrative dollar-for-dollar credit available to employers based on the payroll taxes paid by the employer on an employee’s tip income.
In addition, the Tax Cuts and Jobs Act recently added the employer credit for paid family and medical leave (FMLA) that is available for wages paid through qualifying programs in tax years beginning after December 31, 2017, and before January 1, 2020. If an employer’s FMLA policy qualifies, a credit of up to 25 percent of amounts paid to an employee under the FMLA policy is available.
An analysis of all requirements of the credits described above is beyond the scope of this article. However, given the prospect of obtaining large credits under these programs, taxpayers are advised to consult with their tax advisor to determine what credits they qualify for.
For more information on these issues or on the effect tax reform has had on the hospitality industry, please reach out to your BKD trusted advisor or use the Contact Us form below.