Tax Reform and Your Franchise

It’s been called the most sweeping tax legislation since the Tax Reform Act of 1986, but what does the Tax Cuts and Jobs Act of 2017 mean to you as a franchise owner? The details can be hard to figure out, and—as a business owner—you don’t have a lot of extra time on your hands anyway. Time to turn to an expert for a good overview.

Matthew C. Latham, CPA, is senior manager of tax services at Maner Costerisan, the largest locally owned public accounting and business advisory firm in mid-Michigan. Below he has outlined some of the highlights, and significant changes franchise owners need to be informed on.

Reaction to the Changes

The International Franchise Association (IFA), America’s largest advocate for small and franchise businesses, issued a statement from its president and CEO, Robert Cresanti, applauding the legislation shortly after the U.S. House of Representatives Ways and Means Committee unveiled the tax reform bill in November.

“Today is a great day for the 733,000 franchise businesses and their 7.6 million employees nationwide,” Cresanti said. “Few realize that behind the well-known name brands, there are small-business owners that are struggling as a direct result of the expensive and complex U.S. tax code.”

“Small businesses are the true engine of the U.S. economy, and when they prosper, the effects are felt throughout every sector,” he continued. “With a lower tax rate and a less complicated code like the House has proposed, small-business owners will be more competitive, and they’ll be more likely to expand and, most importantly, they’ll hire more employees.”

“On behalf of America’s franchise community, I would like to commend the U.S. House Ways and Means Committee, the Senate Finance Committee and the administration for the work they’ve done to set the stage for this historic tax overhaul,” Cresanti concluded.

When they signed the measure into law in December, numerous trade associations and food service retailers also welcomed it. Among the statements issued were:

“This bill addresses the needs of small business and will help restaurants remain strong economic engines and job creators.” – Cicely Simpson, executive vice president for public affairs at the National Restaurant Association

“It will help spur job creation within the grocery manufacturing industry and provide tax relief for working families. The food, beverage and consumer products industry has long urged action to fix our broken tax system, which must work in favor of both consumers and manufacturers.” – Pamela Bailey, president and CEO of the Grocery Manufacturers Association

“For years, independent supermarket operators have tried to keep pace with a rapidly changing marketplace while operating in an industry with high effective tax rates on just 1-2 percent profit margins. This new weight lifted off their shoulders will allow stores to invest more in their companies, employees and communities.” – Peter Larkin, president and CEO of the National Grocers Association

“The bill dramatically lowers the corporate tax rate and increases expensing levels, which should help fuel improvements in technology and job growth within the industry.” – Jennifer Hatcher, chief policy officer and senior vice president for government relations for the Food Marketing Institute

Highlights Affecting Businesses

Some of the key changes affecting businesses in the Tax Cuts and Jobs Act of 2017 include:

• Replacement of graduated corporate tax rates ranging from 15 percent to 35 percent with a flat corporate rate of 21 percent.
• Repeal of the 20 percent corporate alternative minimum tax (AMT).
• New 20 percent qualified business income deduction for owners of flow-through entities through 2025.
• Doubling of bonus depreciation to 100 percent and expansion of qualified assets to include used assets.
• Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phase-out threshold to $2.5 million.
• New disallowance of deductions for net interest expense in excess of 30 percent of the business’s adjusted taxable income.
• New limits on net operating loss (NOL) deductions.
• Elimination of the Section 199 deduction, also commonly referred to as the Domestic Production Activities Deduction or Manufacturers’ Deduction.
• New rule limiting like-kind exchanges to real property that is not held primarily for sale.
• New tax credit for employer-paid family and medical leave.
• New limitations on excessive employee compensation.
• New limitations on deductions for employee fringe benefits.

What You Need To Know

The business experts at Maner Costerisan have identified seven primary areas of the Tax Cuts and Jobs Act of 2017 for further explanation to help you navigate the waters of the tax code changes. These areas include:

1. Corporate tax rate reduction: For tax years beginning after December 31, 2017, the top corporate tax rate has been permanently reduced by 40 percent — from 35 percent to a flat-tax rate of 21 percent. In the first several months of 2018, it is important to evaluate the current methods of accounting established by a taxpayer and determine if there are more optimal methods of accounting available under the code and regulations.
2. Pass-through tax treatment/Section 199A: A new deduction of 20 percent of “qualified business income” from a partnership, S corporation or sole proprietorships is now available subject to limits based on an individual’s taxable income, W-2 wages and certain service industries. This deduction could help to reduce the maximum annual individual tax rate on pass-through income from 37 percent to 29.6 percent.
3. Bonus depreciation and expanded Section 179 depreciation: The new law extends and modifies bonus depreciation through 2026 as follows: The 50 percent bonus depreciation is increased to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023. The 100 percent allowance is phased down by 20 percent per calendar year for property placed in service in taxable years beginning after 2022. For property placed in service after December 31, 2017, Section 179 has been expanded and is potentially available to improvement property.
4. Expanded use of the overall cash method of accounting as well as increased exemption from requirement to keep inventory and exemption from UNICAP: The gross receipts threshold that exempts certain taxpayers (C corporations, partnerships with C-corporation partners and tax shelters) from the requirement to use the accrual method of accounting was increased under the tax reform bill from $5 million under current law to $25 million. Also, the gross-receipts test has been increased from $10 million to $25 million for the requirement to compute 263A and can treat inventory as non-incidental materials and supplies or conform to the taxpayer’s method of accounting reflected in an applicable financial statement.
5. Modification of treatment of S-corporation conversions to C corporations: Under the provision, any Section 481(a) adjustment of an eligible terminated S corporation attributable to the revocation of its S-corporation election (i.e., a change from the cash method to an accrual method) is taken into account ratably during the six-taxable-year period beginning with the year of change.
6. Timing of revenue recognition: Under section 451, accrual basis taxpayers generally include income at the earliest of when the income is due, earned or received. In certain instances (e.g., involving contingent consideration), tax may accrue income at a later point in time than books.
7. Eliminate ability to carryback net operating losses and limits on use of NOLs against future income: For tax years beginning after December 31, 2017, an NOL deduction will be limited to 80 percent of taxable income. Plus, the two-year carryback provision has been eliminated, so losses can only be carried forward. The good news is these losses can be carried forward indefinitely. There are additional loss limitations for taxpayers that have pass-through losses on their individual 1040 that go above and beyond the normal passive loss rules that could also prevent full losses to be taken in the current year.

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About the guest author: Originally from Grand Blanc, Matthew C. Latham, CPA, received bachelor’s and master’s degrees in accountancy from Michigan State University, and is an avid Spartan, Lions, Red Wings and Tigers fan. As senior manager of tax services at Maner Costerisan, a full-service public accounting and business advisory firm based in Lansing, Michigan, he helps closely held businesses minimize tax liability while maximizing growth and business value. If you would like more information on how the professionals at Maner Costerisan can help you stay on top of all the changes that come with running a business, visit them at manercpa.com or speak to one of their team members at (517) 323-7500.