With all that has been written about the long-awaited $1.5 trillion Tax Cuts and Jobs Act of 2017, of the most particular interest to Dunkin’ Donuts franchisees may be the comments of Robert Cresanti, the CEO of the International Franchise Association. In a statement issued prior to the signing, Cresanti thanked the Senate for “listening to the concerns of business owners and working to ensure small businesses see tax relief. For years, the burdensome and complex tax code has held back small business owners and stifled new investments.”
While much of the nitty gritty of the new tax laws are still being reviewed, it’s pretty clear that many of the provisions should prove to be a boon for franchisees – particularly in the near term. Of course, for any individual franchisee or franchise group, the insight of a tax professional is critically important to fully understand the various implications. That’s one reason we put a call into Nish Parekh, principal of Neovision Consulting, a Cranbury, NJ-based CPA firm that specializes in franchise restaurants. Parekh also happens to own a Dunkin’ Donuts and a Wingstop restaurant.
“I think this is a good thing, especially for the small business owners,” he says “For franchisees, it will help with growth and planning [as] well as the reduction in taxes. You can then use these savings generated from that reduction to reinvest into the business by hiring additional employees, giving raises or opening up additional locations.”
The reduction in tax rates will be significant for franchisees in the short term because most small business owners are set up as LLCs or S-Corps and pay their personal and income taxes together. For such entities there is a blanket 20 percent reduction of qualified business income for tax years 2018 – 2025.
In the long term, however, Parekh notes the tax law will favor C-corporations, where the company is taxed separately from its owners. Those entities will enjoy a permanently reduced tax rate of 21 percent, down from the prior 35 percent, for the tax years beginning in 2018.
“So the changes allow those in the restaurant business (or any non-service-based industry) to reduce their taxable income by about 20 percent, although there are certain limitations if you cross a certain threshold,” he says.
Among those are changes to the amount business owners can deduct for wages. Other factors can also affect those deductions. To illustrate, Parekh offered the example of a franchisee whose restaurant revenue is $1 million for the year, with $700,000 in total expenses. He has a profit of $300,000. “Out of that $300,000, if – and I emphasize the word if – all the applicable nuances that the franchisee is supposed to have in place are in line, then you can reduce that $300,000 in taxable income by 20 percent ($60,000), and you end up only paying taxes on $240,000.”
The new tax law changes how franchisees can expense the cost of equipment. For the next tax year, there will be a 100 percent first-year deduction for new and used equipment acquired and placed in service after September, 27 2017. But, it’s important to note, this provision will begin phasing out in 2023, and will be eliminated entirely in 2026.
Parekh says he is not overly concerned about the long term implications of the phase out. “In five years there may very well be another provision for small businesses, or they may even extend the existing one, much like the changes that have occurred in past years with the 179 deduction.”
The 179 deduction refers to Section 179 of the IRS tax code, which allows businesses to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year from their gross income. The new tax law increases the maximum threshold for a 179 deduction from $510,000 to $1 million, and increases the spending cap on equipment purchases to $2.5 million. But there are other considerations worth noting.
“This is kind of a double-edged sword,” says Parekh. “There are tax advantages on the business side, but when you have it flow into your personal return, there are new limitations on what your itemized deductions will be.”
As most people have learned through news reports about the law, state and local income tax deductions are being scaled back dramatically. Families will now only be able to deduct up to a total of $10,000 in property and income taxes, and in states with the highest tax rates, that can be problematic. So, while the standard deduction has roughly doubled to $12,000 for an individual or $24,000 for married couples, it may not make up for the loss people realize in after-tax income resulting from the reductions in the state and local deductions.
According to Parekh, there are a number of other changes to the tax code that franchisees should be aware of. They include:
Business Tax Provisions
• Interest Expense Limitation: For tax years beginning 2018, net interest expense in excess of 30 percent of the company’s adjusted taxable income will be disallowed. However, taxpayers with average annual gross receipts for the prior three years of $25 million or less are exempt from this limitation.
• Alternative Minimum Tax (AMT) Repealed: The new law repeals the corporate AMT effective for tax years beginning after December 31, 2017. While AMT is repealed, the new law also generally limits the Net Operating Loss (NOL) deduction for a given year to 80 percent of taxable income.
• Shortened Recovery Period for Real Property: For property placed in service beginning January 2018, the definition of qualified property (i.e. property eligible for bonus depreciation) is changed to eliminate separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property. A general 15-year recovery period and straight-line method for qualified improvement property is imposed. Additionally, the Alternative Depreciation System (ADS) recovery period for residential rental property is shortened from 40 to 30 years.
• Net Operating Loss (NOL): For tax years beginning 2018, NOL deduction is limited to 80 percent of the taxable income. The 2-year carryback rule for NOLs is repealed but can be carried forward indefinitely.
• Like-kind Exchanges (Section 1031): Like-kind exchange rules are limited to apply only to real property that is not primarily held for sale.
• Fringe Benefit Deduction Adjustments: For tax years beginning 2018, fringe benefits rules disallow deductions for entertainment expenses, and the employee transportation fringe benefit. Employee meals are now only 50 percent deductible.
Individual Tax Provisions
• Personal Exemption Deduction Eliminated: For tax years 2018 – 2025, the deduction for personal exemptions is eliminated. Prior to this elimination, the deduction for each personal exemption was $4,150 with a phase out for high earners.
• Mortgage and Home Equity Interest Deduction Limited: For Tax years 2018 – 2025, the deduction for interest on home equity is eliminated and the mortgage interest is limited to loans of up to $750,000 ($375,000 for married filing separately taxpayers).
• Medical Expense Deduction Threshold Temporarily Reduced: For tax years 2017 – 2018, the medical expense deductions threshold is reduced from 10 percent of AGI to 7.5 percent of AGI. Additionally, AMT limitations on deductions of medical expenses does not apply to these tax years.
• Affordable Care Act Individual Mandate Repealed: For months beginning after 2018, the amount of the individual shared responsibility payment is permanently reduced to zero.
• Alternative Minimum Tax (AMT) Retained: For tax years 2018 – 2025, individual AMT is retained with increased exemption amounts and phase-out thresholds.
• Child Tax Credit Increased: For tax years 2018 – 2025, child tax credit is increased to $2,000 per qualifying child under the age of 17 (up from $1,000 per qualifying child). The income level at which the credit phases out are increased to $400,000 for married filing jointly taxpayers ($200,000 for all other taxpayers)
• 529 Accounts Funds Tax-Free Withdrawals Expansion: You can now pay for private elementary and secondary school expenses (private or public) using 529 accounts. Tax-free treatment of these withdrawals will be limited to $10,000 per student per year.
• Exclusion on Sale of Primary Residence Retained: A taxpayer who sells their primary residence may exclude up to $500,000 of gain if filing as married filing jointly ($250,000 if single), provided the taxpayer has owned and used the home as primary residence for two of the previous five years.
The Tax Cuts and Jobs Act passed by Congress has stoked optimism for what tax reform can do for business. Many believe business owners with smaller tax bills will turn around and invest more in their businesses and in the overall economy. Cresanti, of the IFA, says the tax changes will “supercharge the economy,” and prompt franchise owners to “hire more employees, expand operations, open more locations and give more back to their communities.”
That has always proved to be a successful business strategy for Dunkin’ Donuts, so we will have to see how it plays out.