Commentary

One year after tax reform: How are restaurants faring?

The benefits provided by the Tax Act may leave restaurants with spare capital to spend, providing cash-flow relief from sluggish same-store sales and higher labor costs

December 20, 2018

By Adam Berebitsky and Lisa Haffer

Enacted at the end of 2017, the Tax Cuts and Jobs Act is the most substantial overhaul of the tax code in recent memory. But while the promise of lower tax rates and a new deduction for Qualified Business Income initially garnered favorable press for the Act, the Act has yielded just as many questions as answers in the year since its passing.

While the "big news" when the Tax Act was signed was that restaurants structured as C-corporations would enjoy a decreased corporate income tax rate of 21 percent (down from 35 percent), owners of restaurants that operate as flow-through entities, such as LLCs or S Corporations, also received welcome news in the form of a new 20 percent deduction of Qualified Business Income. In order to maximize the benefit of this deduction, many restaurants structured as S Corporations began paying reduced (but still reasonable) compensation to their owners in 2018. By doing so, these restaurants have reaped employment tax savings, and their owners have similarly benefitted from a higher QBI deduction and reduced federal income tax liabilities. LLCs may be able to employ the same technique by lowering guaranteed payments or paying preferred returns in lieu of guaranteed payments.

Despite the favorable results expected to be generated by reduced rates and the new QBI deduction, uncertainty exists with respect to a provision of the Tax Act that impacts restaurants significantly: bonus depreciation for Qualified Improvement Property. As written, the law provides an immediate write off in the form of 100 percent bonus depreciation for restaurant furniture and equipment, as well as for land improvements, such as parking lots. However, in what appears to be an inadvertent drafting error, enhanced bonus depreciation does not currently extend to QIP (i.e., interior renovations to existing property). Restaurant operators and tax professionals alike are keeping an eye on legislation that will expand the definition of property eligible for bonus depreciation to include QIP. Such corrective legislation could incentivize restaurants to proceed with store remodeling projects in 2019 that they may have put on hold pending the technical corrections.

The benefits provided by the Tax Act may leave restaurants with spare capital to spend, providing cash-flow relief from sluggish same-store sales and higher labor costs. Looking ahead to 2019, it is expected that restaurants will invest their tax reform savings into their workforces, as restaurants are expected to continue facing labor challenges.
Labor, however, isn't the only area in which restaurants are reinvesting their tax-reform savings. Many restaurant companies are funneling their savings into much needed technological updates.

McDonald's, for example, allocated $2.4 billion of its savings towards expanding their digital capabilities. Specifically, the fast food titan ramped up the installation of consumer-friendly ordering kiosks into its stores and invested in technology designed to enable seamless digital ordering and delivery. These efforts coincided with the third-party delivery boom of 2018, and many smaller chains followed suit over the course of the year.

One year post-enactment of the landmark Tax Cuts & Jobs Act, most restaurants anticipate a net-positive impact on their overall tax position, thanks largely to decreased corporate tax rates, enhanced bonus depreciation and a new deduction for Qualified Business Income — and the savings couldn't come at a better time. Amidst labor challenges and an ongoing race towards a seamless, digitized customer experience, restaurants are using their tax savings both to attract and retain talent, as well as to expand their technological and delivery capabilities.

Adam Berebitsky, CPA and Tax Partner, leads BDO's Restaurant Practice and serves as an adviser to restaurant companies and their owners
Lisa Haffer CPA, JD and Tax Partner, co-leads the tax side of BDO's Restaurant Practice.

Cover photo: iStock

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