by Tom Gresham
The signing of the Tax Cuts and Jobs Act (TCJA) into law in December 2017 marked the arrival of new opportunities and challenges for taxpayers in the United States, and the hospitality industry has been among the fields working to survey and navigate this previously unexplored tax landscape.
At CSG Strategic Tax Consultants, a national provider of business and commercial tax services based in Norfolk, VA, Robert Burke, tax manager/hospitality niche lead, and Director Matthias (Matt) Needam say the hospitality industry and others have a host of considerations to weigh because of the new tax law, though some primary topics have emerged that are receiving the most attention.he signing of the Tax Cuts and Jobs Act (TCJA) into law in December 2017 marked the arrival of new opportunities and challenges for taxpayers in the United States, and the hospitality industry has been among the fields working to survey and navigate this previously unexplored tax landscape.
“Taxpayers are primarily re-evaluating their ownership structure, accounting methods, and estate planning to make sure they are in the best position to both take advantage of the benefits and mitigate the detriments of the tax law changes,” Burke says.
Burke and Needam shared insights into the implications of the tax plan on the hospitality industry and how those in the industry can respond.
Needam said the most critical impacts of the tax plan on the hospitality industry, hotel owners, and investors are those stemming from the new qualified business income (QBI) deduction, the expansion of bonus depreciation and Section 179 expensing, the limitation on business interest, and the doubling of the estate tax exemption.
Noncorporate taxpayers can use the QBI deduction to deduct up to 20 percent of domestic qualified business income from a partnership, S Corporation or sole proprietorship, Needam notes, though the deduction is limited by the larger of 50 percent of wages or 25 percent of wages plus 2.5 percent of the unadjusted basis in fixed assets.
“There are also proposed entity aggregation rules, adding a layer of complexity but also a potential benefit for taxpayers,” Needam says. “This will require hospitality investors to re-evaluate their entire ownership structure to ensure they are able to maximize the benefit of their deduction.”
In addition, under TCJA, Needam says property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2027, now carries a bonus depreciation rate of 100 percent and eligibility now includes used properties. The code Section 179 limitation, which allows businesses to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year, rose to $1 million, the investment limitation grew to $2.5 million, and the definition of qualified real property now includes roofs, HVAC, and alarm, fire, and security systems, Needam says.
“Beyond the tax benefit of the increased depreciation, there’s also an opportunity with the proper planning to increase a taxpayer’s QBI deduction basis,” Needam says. “In the past, significant repairs were simply written off. But now, property owners should consider capitalizing and fully depreciating the items to increase their QBI deduction. This will need to be balanced against state conformity to avoid increasing state taxes disproportionately to the federal deduction.”
Burke says changes in the limitation on business interest remain somewhat murky. For any tax year after 2017, the deduction of business interest is limited to the sum of the taxpayer’s business interest income and 30 percent of adjusted taxable income, Burke says, with an exception for small businesses with average gross receipts of $25 million or less. Many highly leveraged acquisitions could be affected, Burke explains, but “significant clarification is still needed before taxpayers can begin to make fundamental changes to their entity and financing structuring to mitigate the impact of this limitation.”
Burke says clarification is expected soon.
“Depending on whether aggregation rules are established, real estate owners may need to look at rebalancing their real estate portfolios such that debt is allocated in proportion to the profits of the business,” he explains.
The TCJA features a provision doubling the estate tax exemption from $5 million per person to $11 million per person. Because the provision was approved through reconciliation, Burke says, “We’re not sure how much longer this provision will be around.”
“Many hotel owners are examining their estate documents to make sure they are maximizing the value of this new law, given the potential brief window in which it might be here,” he says.
Excess business losses, C Corps and S Corps
Burke and Needam point to several other important changes relevant to the hospitality industry, including the disallowance of excess business losses.
“The elimination of excess business losses will require taxpayers to evaluate their current business structure and tax projections to help reduce the impact of the disallowance, as well as plan for a potentially increased tax liability,” Burke shares.
According to Burke, the C Corporation option has not been used typically in the hospitality industry in the past partly because of the relatively high corporate tax rate. Under the new law, however, the corporate tax rate drops from 35 percent to 21 percent and “presents an opportunity for taxpayers with specific business structures to use the C Corp. entity type to their advantage.”
A key new compliance requirement for individual tax returns is that S Corporations need to properly calculate their basis in each entity as part of a required disclosure, Burke says.
“Many individuals may not be aware that their basis is insufficient to take losses from some of their properties,” he says.
Carried interest, and state and local taxes
Hotel developers who structure their deals to take advantage of the favorable long-term capital gains tax rate on carried interest will see particular effects from the TCJA.
“A ‘carried interest’ in a partnership is an interest that consists of the right to receive future partnership profits and is given to a partner in exchange for performing services for the partnership,” Burke explains. “As part of the Tax Cuts and Jobs Act, the holding period for long-term capital gains from carried interest was increased from one to three years. As this change could nearly double the potential tax liability for the taxpayer, the entire structure, investment strategy, and deal timing may need to be re-evaluated.”
Burke and Needam don’t expect differences in the regional impacts of the tax law on the hospitality industry. However, the deduction of state and local taxes on an individual’s return are now limited to $10,000 ($5,000 for married, filing separate).
“Individuals living in states with higher tax rates will be more negatively affected as they will only receive a benefit for a smaller portion of their overall state tax liability,” Burke says.
The ongoing impact of the tax law
Projecting the long-term impact of the TCJA is especially difficult because of the political climate that surrounds it.
“Depending on the party in power, the regulations could swing significantly in either direction,” Burke says. “The most important thing is for taxpayers and their advisors to fully understand each regulation and be sure to make changes based on certainty rather than expectation. We will all need to stay ahead of the changes to plan properly but also understand the difference between final and proposed regulations before altering our business models.”
In the meantime, Burke believes taxpayers should be proactive to ensure they net potential benefits now while they are available.
“There is no true certainty in regards to how long these new deductions and reduced rates will be available,” he says. “We’re actually seeing some taxpayers choose to accelerate income into the current period under the current historically low rates.”