In 2014, the IRS issued guidance, which over the last several years has made a significant impact on how hotel, restaurant, and food distribution owners capitalize and depreciate assets placed into service. Effective for tax years beginning January 1, 2014, the tangible property regulations regulate the treatment of normal repairs and maintenance versus an improvement to an asset. The regulations also clarify whether fixed asset additions must be capitalized or expensed immediately.
Wondering how this applies to your business, and if you need to make changes to take advantage of potential savings? Find out below.
What must be implemented?
All taxpayers that have depreciable fixed assets must have a capitalization policy that determines the threshold under which a fixed asset or an improvement to a unit of property is to be capitalized and depreciated. Under the new regulations, the IRS will allow a business without audited financial statements to have a “safe harbor” threshold of $2,500 per unit of property and $5,000 per unit of property for business owners with audited financial statements. While taxpayers are allowed to use higher capitalization thresholds, the taxpayer must be able to justify using a threshold above the allowed safe harbor amount in the event of an audit.
What is considered an “improvement to a unit of property”?
Business owners must make the distinction between routine maintenance and an improvement to a specific asset or unit of property. Improvements to a unit of property that must be capitalized and depreciated over its useful life are defined as betterments, a restoration to an original state, or an adaptation to a new use. Examples of a unit of property can include the building, HVAC system, and electrical system. Common improvements for hotel and restaurant owners could include expanding the hotel building or a restaurant conducting renovations to the inside of the building space used for restaurant operations.
What is considered routine maintenance?
Routine maintenance may be written off if the action will be completed more than once over a ten-year period. This could include hotel owners putting down new asphalt in the hotel’s parking lot every five years or restaurant owners replacing the floor titles of their restaurant every few years.
Can you deduct materials and supplies?
Under the regulations, there is a set de minimis of $200 or a useful life of 12 months or less that can be expensed immediately upon purchase. This allows hotel, restaurant, and food distribution owners to immediately expense items such as bed linens, glassware, tablecloth linens, utensils, and manufacturing supplies.
What are the opportunities under the regulations?
The regulations require great diligence in both year-end tax planning and tax return preparation, but do allow for substantial tax savings techniques for hotel, restaurant, and food distribution owners. Accelerated deductions of asset additions could be obtained under the tangible property regulations. If a unit of property such as a HVAC system or electrical system is placed in service and it replaces an old system, the business owner may be able to write off the old HVAC or electrical system that was replaced.
Each year, business owners should review their fixed asset purchases to determine if there are any additions that can be directly expensed or if there are any prior fixed assets additions that can be disposed of. Please reach out to us if you have any questions or would like more information on the tangible property regulations and the impact it can have for a restaurant, hotel, food distributor, or company that services the hospitality industry.
The Protecting Americans from Tax Hikes Act (“The Act”) was signed into law by the President on December 18, 2015. The Act includes a number of significant tax changes. Some of the more important changes effective after December 31, 2014, (unless indicated) are as follows:
• R&D Credit – The Act retroactively and permanently extends the research credit and may be used as an offset against Alternative Minimum Tax (AMT) in certain situations. No changes were made to the calculation method of the R&D credit.
• R&D Credit – Offset against AMT. The Act provides that the R&D credit can be claimed against an AMT offset for an eligible small business (ESB), which is defined as a business with $50 million or less of gross receipts effective January 1, 2016.
• R&D Credit – Offset against payroll taxes. Effective after December 31, 2015, the Act provides that a qualified small business (QSB), which is defined as having gross receipts of less than $5 million in current year and not having gross receipts for more than $5 million in the prior year, is eligible to offset their R&D credit against their payroll taxes. The maximum payroll tax offset is $250,000.
• Section 179 – The $500,000 expensing limitation and $2 million phase-out amounts are retroactively extended and made permanent; after 2015, the limits are indexed for inflation.
• Section 179 – The rule that allows expensing for off-the-shelf computer software is retroactively extended and made permanent.
• Bonus Depreciation – The Act extends bonus depreciation for qualified property acquired and placed in service during 2015 through 2019 (50% for 2015-2017, 40% for 2018, and 30% for 2019).
• Qualified Leasehold Improvements – The Act retroactively extends and makes permanent the inclusion of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property in the 15-year Modified Accelerated Cost Recovery System (MACRS) class.
• Built-In-Gains Tax – The Act retroactively and permanently provides that for determining the net recognized built-in gain, the recognition period is a 5-year period.
• Work Opportunity Credit – The Act retroactively extends the work opportunity credit so that it applies to eligible veterans and non-veterans who begin work for an employer before January 1, 2019. With respect to individuals who begin work for an employer after December 21, 2015, the credit applies to employers who hire certain qualified unemployed individuals. The credit with respect to such long-term unemployed individuals is 40% of the first $6,000 of wages.
• Empowerment Zone Tax Incentives – The Act extends for two years, through December 31, 2016, the period for which the designation of an empowerment zone is in effect.
• New Market Credit – The Act retroactively extends the new markets tax credits through 2019. It provides up to $3.5M in qualified equity investments for each calendar year from 2015 through 2019. The carryover period for unused new markets credits is extended through 2024.
• Exclusion of Gain from Certain Small Business Stock – The Act retroactively and permanently extends the 100% exclusion and the exception from minimum tax preference treatment.
• Tax-free IRA Transfers to Charities – The Act retroactively and permanently extends the ability of individuals at least 70½ years of age to exclude from gross income qualified charitable distributions from IRAs of up to $100,000 per year.
• Mortgage Insurance Premiums – The Act retroactively extends this provision for two years so that a taxpayer can deduct, as qualified residence interest, mortgage insurance premiums paid or accrued before January 1, 2017.
• Qualified Tuition Deduction – The Act retroactively extends through 2016 the above-the-line deduction for qualified tuition and related expenses for higher education.
• American Opportunity Tax Credit (AOTC) – The Act makes the AOTC permanent.
• Child Tax Credit (CTC) – The Act makes the enhanced CTC permanent by setting the threshold dollar amount for purposes of computing the refundable credit at an unindexed $3,000.
• Look-through Rules for Payments between Related to Controlled Foreign Corporations (CFC) under the Foreign Personal Holding Company Income — The Act retroactively extends the look-through treatment for related CFC’s for five years making it applicable to qualifying CFC’s for tax years beginning on or before January 1, 2020, and to the tax year of US shareholders with or within the tax years of the qualifying CFC end. This rule provision generally permits the tax treatment of the receipt of dividends, interest, rents, and royalties income items as non- foreign personal holding income (FPHCI) sources and does not require immediate income inclusion for US tax reporting purposes provided that such income items under the look through provisions are determined to be attributable or properly allocable to non-subpart F income, or such income items are determined to be not effectively connected with the conduct of a US trade or business of the payer.
Maryland taxpayers that have received refunds or filed refund claims because of the decision in Comptroller v. Wynne can preserve their right to receive the full 13% interest taxpayers are typically paid on refunds. Last year, Maryland enacted legislation stating taxpayers receiving Wynne-related refund claims would only be paid the prime interest rate rounded to the nearest whole number, instead of the general rate of 13%. Thus, the current interest rate being paid on Wynne refund claims is only 3%; the legislation is expected to be challenged in court on constitutional grounds. A number of taxpayers seeking the full 13% interest rate have already filed appeals with the Comptroller.
In anticipation of litigation on this issue, the Comptroller has established a procedure whereby taxpayers can challenge the interest they received on their Wynne refunds. A summary of the procedure is below.
The Comptroller has indicated that it is currently processing protective refund claims filed in 2014. All protective claims (i.e., claim filed before the Wynne decision was issued in May of 2015) are expected to be processed by the end of the year. This means that most of the refund claims that have been submitted since the Wynne decision was issued will likely not be processed until 2016.
If you have questions related to a Wynne refund claim or another Maryland tax issue, please contact your Aronson tax advisor or Michael L. Colavito, Jr.at 301-231-6200.
The IRS has announced proposed regulations to address the definitions of various terms in the Tax Code relating to marriage, in view of the 2013 U.S. v. Windsor Supreme Court decision striking down part of the Defense of Marriage Act as unconstitutional, and of the 2015 Obergefell v. Hodges Supreme Court decision that same sex couples have a fundamental right to marry in any state, thus rendering state bans unconstitutional.
The proposed regulations effectively state that:
These regulations, if adopted, will have far reaching consequences to same sex married couples who have otherwise been filing single returns for each spouse. The regulations do not apply to other relationships such as civil unions or registered domestic partnerships.
For questions about your specific tax situation, please contact Larry Rubin, CPA, Aronson’s tax controversy practice lead, at 301-222-8212.
Alabama has revoked a twenty-year-old sales tax ruling, and in doing so has ruled that electronically transmitted information is taxable tangible personal property for sales tax purposes. The notice issued by the Alabama Department of Revenue on September 3, 2015 cites advances in technology and analogous expansions of the definition of “tangible personal property” to canned (i.e., prewritten) software and electricity as support for it decision. Alabama’s decision seems troubling when considering the otherwise limited application of it sales tax and the means by which it has expanded its sales tax in the past.
The application of a state’s sales tax to what most states consider a service (i.e., an information service) is typically accomplished by the enactment of a statute that specifically enumerates the service as being subject to sales tax. Alabama’s informal memorandum (which seems to be the best characterization of the document issued by the Department) is a prime example of a significant change in tax policy being established by an administrative agency. Other states have issued similar informal guidance, for example, by ruling that sales tax applies to software-as-a-service (SaaS). However, states that have administratively concluded that SaaS is taxable have largely already had an enacted statute stating that canned software is taxable regardless of the method of delivery. In such case, the taxing authority is arguably making a reasonable interpretation of existing law. Here, Alabama does not otherwise tax information services.
The expansion of Alabama’s tax base to canned software was accomplished through an Alabama Supreme Court case in 1996, which held that canned software is “tangible personal property.” The Department of Revenue subsequently promulgated a regulation addressing the taxation of computer software in more detail. Thus, in the case of software, the Department had a decision of the state’s highest court that it was interpreting. The Department’s reliance on that very case, which addressed the narrow issue of whether canned software is subject to sales tax, to support its conclusion that electronically transmitted information is also tangible personal property is quite a stretch.
This is especially the case given the fact that Alabama does not otherwise tax information services. How expansive are taxpayers to interpret this pronouncement? Is all electronically transmitted information now taxable? Can sales tax be avoided if the information is delivered in hard copy because the application of the “true object” test, which Alabama applies, results in the principal purpose of the sale being a nontaxable transfer intangible property?
Essentially, Alabama’s notice leaves taxpayers, both those providing information services online and in a tangible form, with a significant amount of uncertainty. Still, this is not terribly surprising, given the slow nature of state legislatures to react to new methods by which products and services are delivered. Tax administrators across the country are routinely faced with similar questions requiring them to fit a square peg into a round hole. Unfortunately, the conclusions are anything but uniform; leaving taxpayers, especially those offering products and services online to customers in multiple states, with a certain level of risk.
If you are interested in learning more about how states are taxing technology companies, please join us for our upcoming webinar series: Taxing Tech. If you have questions about the application of sales tax on your products or services, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.