Big Tax Ideas that Save Real Money

Gerry Adams, CPATax Partner

Richard Finafrock, CPATax Principal

Allison Gillette, CPATax Manager

Marney Zellers, CHAEHospitality AdvisorNovember 10, 2014

The material appearing in this presentation is for informational purposes only and is not legal or accounting advice. Communication of this information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although these materials may have been prepared by professionals, they should not be used as a substitute for professional services. If legal, accounting, or other professional advice is required, the services of a professional should be sought.

Disclaimer

Outline1. Section 179 Election & Bonus Depreciation

2. Capitalization Policies & Repair Regulations

3. Washington State Excise Taxes

4. Tips and Service Charges

5. Personal Property Taxes

Section 179 &Bonus Depreciation

IRC Section 179 Election• Businesses can elect to expense part or all of the cost of

new or used qualified property subject to limitations.• Income Limitation

• Entity Level• Individual Level

• Investment Limitation• Maximum spending on asset additions during the

year• Phase-outs

IRC Section 179 Election

$200,000

$400,000

$410,000

$420,000

$430,000

$500,000

$800,000

$2,000,000

$200,000

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

$1,800,000

$2,000,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Investment Limitation

Investment Limitation

IRC Section 179 Election

$20,000 $24,000

$24,000

$100,000 $102,000

$105,000

$108,000

$125,000

$250,000

$500,000

$25,000

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

$500,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Maximum 179 Expense

Maximum 179 Expense

Bonus Depreciation Allowance• Businesses have been allowed an accelerated treatment to

expense a percentage of the adjusted basis on qualified property purchases.

• Qualifying property• Original use begins with taxpayer• Depreciable property with a 20 year or less life

• Taxpayers must elect out in order to not claim this allowance on property class types.

Bonus Depreciation Allowance

0%

30% 30%

50% 50%

0% 0% 0%

50% 50% 50%

100%

50% 50%

0%0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Bonus Depreciation

Bonus Depreciation

Asset Lives

**Expired December 31, 2013

Property Description Tax Life Eligible for Sec. 179 or Bonus**

Furniture 7 years Yes

Restaurant Furniture 5 years Yes

Fixtures 7 years Yes

Equipment 5 years Yes

Software 36 months Yes

Building 39 years No

Improvements 39 years No

Qualified Leasehold Improvements**

15 years Yes

Qualified Restaurant Property** 15 years Yes

Capitalization Policies & Repair Regulations

Capitalization Policies• New IRS regulations

– Safeharbor Capitalization Policy –• New Additions/Purchases

– Election is made on each year tax return» Companies with applicable financial statements is $5,000» Companies applicable financial statements is $500

• Materials and Supplies– Safeharbor for purchases is $200

• Smallwares

Safeharbor: Provisions in a regulation that affords protection from a liability or penalty under specific situations or if certain conditions are met.

Expense or Capitalize• Betterment or Improvement:

– extends the life, – increase the capacity, or – improve the efficiency or safety of the property

• Unit of Property– Building structure– Building systems – Defined 8 systems:

- All Elevators- Fire Protection System- Security System- Gas Distribution System

- HVAC- Plumbing System- Electric System- All Escalators

Expense or CapitalizeEXAMPLE

Assumptions:• Building acquired 1999• Room renovation occurred in 2010

ORIGINAL TAX TREATMENT

2014 -> 12/31/13 12/31/13 Annual

Accumulated Undepreciated Depreciation Cost Depreciation Cost Expense

Original Building - 1999 10,000,000 (3,846,150) 6,153,850 256,410 Room renovation - 2010 2,000,000 (205,128) 1,794,872 51,282

Totals 12,000,000 (4,051,278) 7,948,722 307,692

Expense or CapitalizeEXAMPLE

Assumptions:Building acquired 1999Room renovation occurred in 2010: Determined that $500k of renovation was for "betterments”

TAX TREATMENT UNDER NEW REGULATIONS

2015 -> 12/31/13 12/31/13 Annual

Accumulated Undepreciated 2014 Depreciation Cost Depreciation Cost Expense Expense

Original Building - 1999 10,000,000 (3,846,150) 6,153,850 256,410 256,410 Room betterments - 2010 500,000 (51,282) 448,718 12,821 12,821 Rooms "refresh" - 2010 1,500,000 (153,846) 1,346,154 1,346,154 -

Totals 12,000,000 (4,051,278) 7,948,722 1,615,385 269,231

Expense under Original Treatment 307,692 307,692

Difference 1,307,693 (38,461)

Repair Safeharbor• Building Repair Safeharbor

– Maintenance performed is reasonably expected to occur more than once during a 10 year period can be expensed

• Other Property Safeharbor– Maintenance performed is reasonably expected to be performed more than once

during the property’s life class can be expensed

Disposals• Final regulations issued by IRS in August 2014

– Effective for tax years that begin on or after 01/01/2014– Can adopt for tax years that being on or after 01/01/2012 (options)

• Retirement of structural components of a building – Partial disposition

• O.K. to use any reasonable method to determine basis of retired asset– Cost segregation study– Discounted cost using the Producer Price Index

Disposals

* Question: Is this amount "reasonable"?- It represents the cost of a new roof in 2011- How long should the roof last?- Should a "condition factor" be considered?

PARTIAL DISPOSITION EXAMPLE

Assumptions:Building acquired in 2011Roof replaced in 2014 for $200,000New roof of comparable type to old

Capitalize cost of new roof $200,000 Depreciate over 39 years Basis of old roof ($200k discounted back 3 years) $186,000 Expense in 2014 *

Washington State Excise Taxes

Common Paymaster – Shared Costs• Common paymaster taxation treatment

• The requirements for a deductible advance or reimbursement are:

Requirements:– Funds are received as the agent of a customer or client– Use of funds to pay third parties is solely that of an agent– The taxpayer receiving the advances or reimbursements does not or cannot render

the services provided– The taxpayer receiving the advances or reimbursements does so in the normal

course of business

Common Paymaster – Shared CostsRecord Keeping Requirements:

• There are certain record keeping requirements– There must be a contract or agreement between the parties clearly defining the

relationship– The books and records of the agent must show the transactions were made in the

name and for the account of the principal and the actual buyer for whom the purchase was made

– The books and records of the agent must show the gross sales, the amount of any commissions and any other incidental income derived by the agent from such sales

Common Paymaster – Employee Costs• New section added to Washington laws payroll services

– A deduction is allowed for an employer who provides paymaster services for an affiliated company covering employee costs.

– However, no exclusion is allowed for any employee costs incurred in the connection with a contractual obligation of the taxpayer to provide services, including staffing services.

Common Paymaster – Employee CostsSummary – Common Paymaster Structures:

• Decide if these structures make sense– Will the company save money?

• Can the company consistently abide by the requirements of the new rules for employees costs and for shared costs?

– Contracts are important

– Liability burden is important

– Communications are important

• Will the company operate in substance according to the form of the transactions?

• Will the company protect itself from future tax liability by seeking letter rulings?

Market Based Apportionment• Applies to both state and local Business & Occupation tax

• Local jurisdiction apportionment is different than state apportionment

• Multiple changes in methodologies since 2006– June 1, 2010– Market Based versus Cost Based– Sales Factor Apportionment

• Nexus - “Physical presence” in another state is not the test for many businesses

• Economic nexus thresholds ($267K/53K/53K) only applies to apportionable activities

Tips and Service Charges

QUESTION

Is it a Tip or a Service Charge?

Service charges differ from tips in the following way:a) Tips are subject to the employer matching FICA tax but service

charges are not.b) Tips can be considered toward minimum wage in states with a

tip credit while service charges may not.c) Service charges belong to the employer while tips belong to the

employee.d) All of the above.

Tips vs. Service ChargesTips vs. Service Charges - Defined

Tips Service ChargesPayment is free from compulsion Payment is required

Customer has unrestricted right to determine amount

Amount is determined by someone other than customer

Generally, the customer has the right to determine who receives the payment

Someone other than the customer determines who receives the payment

Tips vs. Service ChargesTips vs. Service Charges - Treatment

Tips Service ChargesReported to IRS as tip income and eligiblefor the FICA tip credit

Reported to IRS as wages and not eligible for the FICA tip credit

Legally belong to the person for whom the customer intended payment. Employer distribution of tips to those other than said person are limited.

Legally belong to employer. Treated as income and subject to sales tax in applicable states. Employer retention and distribution of payments more liberal.

Count toward meeting minimum wage requirement in states with tip offset (tip credit)

Count toward meeting minimum wage requirement in states with tip offset (tip credit)

Included in hourly rate used to determineovertime rate

Tips vs. Service Charges

Automatic Gratuity

• Commonly referred to as “Auto Grat”

• Commonly added to restaurant checks of larger parties

• Automatic gratuity policies are commonly written on menus and verbalized by front desk staff

• IRS Rev. Ruling 2012-18 declares auto grat to be a service charge, not a tip

Tip Reporting

When declaring tip income, the IRS requires an employee report:a) At least 8% of the employee’s total salesb) 10% of the employee’s total sales or 100% of credit card tips,

whichever is higherc) 100% of credit card tips plus 10% of the employee’s cash salesd) None of the above

QUESTION

Tip Reporting

Tip Reporting - Requirements

Employee

Keep a daily record of tips and sales

Employee who receive $20 or more in tips, either directly or indirectly, in a month must report all tips to the employer by no later than the 10th day of the following month. (Employers may require employees to report tips more often.)

Tip ReportingTip Reporting - Requirements

EmployerCollect employee tip reportsWithhold and pay Social security, Medicare and federal income taxes on all employee tipsEmployers must match employee’s Social Security and Medicare taxes on all employee tips (NOTE: this is true whether or not the employee reports the tips)

When preparing an employee's Form W-2, include wages, tips and other compensation in the box labeled "Wages, tips, other compensation." Include Medicare wages and tips, and social security tips in their respective boxes.

When figuring the employer's liability for federal unemployment tax, add the reported tips to the employee's wages.

Allocate tips to any directly tipped employees who reported tips of less than 8% of his or her sales.

File Form 8027 if tipping is customary, food and drink are provided for consumption on premises andthe business employs more than 10 employees or the equivalent (more than 80 employee hours per day) on a typical day.

Tip Audits

TRUE or

FALSE

In a tip income audit, the IRS focuses solely on recovering income tax from employees who underreport their tip

income.

QUESTION

Tips AuditsTip Audit Facts

The IRS has the right to audit at least as far back as three years - further, if the agency believes it's a case of fraud. Some restaurant servers have even been jailed for tax evasion.

Courts continue to hold that the IRS may use indirect and aggregate methods for determining underreported tip income in audits where employee tip reporting records are incomplete or in employer-only audits.

In an employer-only audit, the determination is made through an observation that the overall rate of tips for a restaurant is not high enough. Audits are made without auditing the employees of the restaurant.

Along with requiring employers to pay their share of FICA taxes on underreported tip income, the IRS may also assess penalties to employers equal to the EMPLOYEE portion of FICA taxes.

Tips Audits

Triggering a Tip AuditRed Flags

Percentage of total reported tips relative to total sales is below industry average

Credit card tips reported on form 8027 exceed total tips declared to employer by employees

Percentage of reported cash tips relative to cash sales is significantly lower than that of credit card tips to credit card sales

Best Practices

Common Issues

Issue Best Practices

Auto gratuity is common in your business. Reduced FICA tip credit would have a major impact on operating income.

• Consider reducing use of auto gratuity and printing suggested tip amounts on guest checks

• Retain a portion of the auto gratuity for the house

Employees underreport tips• Strong policy including tip allocation policy• Tip reporting training and education• Tip Agreements (TRDA, TRAC, emTRAC)

Personal Property Taxes

Personal Property TaxesThink about these questions:

• Has there been significant new investment in equipment, furniture or fixtures?

• Does the fixed asset list include older assets that may no longer be physically present?

• Are you reporting the full capitalized cost for tangible personal property?

• Has a cost segregation study been performed?• Have the assets been the subject of a purchase price allocation?

Answering “yes” to any of the above, could warrant a PPA review.

Personal Property TaxesIssues to consider:

• Real vs. Personal property: Classification of assets may differ for PPA purposes vs federal tax

• Sales tax, freight, installation, and warranties: May or may not be includible in cost

• Economic obsolescence: Market sales may indicate cost less depreciation is more than FMV calculated

• “Ghost assets”: Assets disposed of, but still included on the PPA

Questions?

Thank you for attending!

Contact Information:Gerry Adams- gadams@pscpa.comRichard Finafrock- rfinafrock@pscpa.comAllison Gillette- agillette@pscpa.comMarney Zellers- mzellers@pscpa.com