As many restaurant franchisees are currently contemplating the need to make capital improvements to their restaurants, the recently enacted Small Business Jobs Act of 2010 has provided significant income tax benefits to help lessen the financial burden of such expenditures.
The Small Business Jobs Act, enacted on September 27, 2010, provided a variety of tax breaks for small businesses, primarily focused on incentives to promote capital spending. Accordingly, the Act provides benefits for those operators that are considering small equipment upgrades or even thinking of making substantial improvements to their restaurants. The major provisions include:
Increased section 179 expensing
The maximum amount a business may expense under Section 179 has increased to $500,000, and the phase-out threshold amount has increased to $2 million for tax years beginning in 2010 and 2011. In addition, the $500,000 maximum Section 179 expense may include up to $250,000 of certain types of real property, including qualified leasehold improvements and qualified restaurant property. Keep in mind that a Section 179 deduction cannot create a taxable loss, so your overall deduction may be limited.
Qualified restaurant property includes a building or an improvement to the building of at least 50 percent of the building’s square footage is devoted to the preparation and consumption of prepared meals. This may be the most favorable tax legislation related to depreciation of real property that we have ever seen, and it is directed towards the restaurant industry!
Extension of 50% bonus depreciation
The first-year 50 percent bonus depreciation rules are extended by one year for new business property acquired and placed in service during 2010. The bonus depreciation rules are allowed in addition to the Section 179 expense and regular tax depreciation deductions.
The interaction of these provisions can become complex, but may be illustrated by the following example:
Assume that a franchisee incurs $250,000 of capital expenditures related to large equipment upgrades in 2010, as mandated by its franchise agreement. The operator has $150,000 of taxable income in 2010, before considering the impact of the capital expenditures. The operator could be eligible for tax deductions of $210,000 (that’s 84% of the cost of the upgrades!) during the first year as follows:
$150,000 Section 179 expense (Eligible up to $500,000 but limited by taxable income) + $50,000 Bonus depreciation (50% of remaining $100,000 cost after Section 179 expense) + $10,000 Regular tax depreciation (20% of remaining $50,000 cost after Section 179 expense and bonus depreciation).
To deduct or not to deduct?
With current income tax rates currently set to expire at the end of 2010, potentially giving way to higher marginal income tax rates for small business owners, an interesting question to consider is whether a restaurant operator should actually claim the maximum tax depreciation deduction for 2010, or consider spreading the tax deduction over future years when the tax rates and, therefore, the tax benefits could be greater.
Although this argument is worth consideration, the best answer is generally to maximize your current depreciation deductions. It is true that a deduction in a future year may be worth more in that year as income tax rates increase; but the current benefit of a deduction that may otherwise be 10 or even 15 years away will typically outweigh any future benefits.
Ultimately, the benefits of some tax law changes, such as the expanded depreciation deductions provided under the Small Business Act of 2010, are sometimes just too good to pass up.
Richard Yelton is a principal at Windham Brannon in Atlanta. His specialties include restaurant and hospitality tax, mergers and acquisitions, and more.
Visit him at the Windham Brannon website.