Once a year this column attempts to provide the franchise business reader with tax savings and year-end planning ideas that are unique to the franchise world. The ideas in this column are starting points to discuss with your tax advisor and possibly incorporate into your year-end planning.
Every franchisor should address the following hot topics with its tax advisor while there is still time to plan:
A fast-growing franchisor experiences significant deferred revenue under this standard, which may result in a problematic balance sheet that shows minimal net worth but substantial cash and a large liability for deferred revenue. The solution is to make specific allocations of the franchise or development fees for specific types of services. If specific types of assets have been delivered (e.g., point of sale software, initial supplies), allocate part of the franchise fee to those assets. If certain pre-opening services are performed and stand alone (e.g., hiring initial staff), make sure the fees and specific amount for training responsibilities are identified separately. Confirm that the multi-unit development obligation is not tied to the number of stores opened but to a specific, definable period of time after which the franchisor services cease. Again, these GAAP rules may not diminish the tax, but they are important for the financial viability of many franchisors and their ability to build a franchise.
The following are general rules that apply to operating companies owned by franchisees and the corporate store activities of franchisor.
1. New Asset Capitalization Rules. The IRS has released long-awaited comprehensive proposed regulations on the capitalization of tangible assets. The lengthy regulations attempt to simplify and clarify rules that virtually touch every business. The rules provide a straightforward 12-month “bright-line” rule—a taxpayer cannot capitalize amounts paid to acquire or produce a unit of property that has a useful life less than 12 months. A similar rule was adopted in the intangible regulations. Further, the regulations provide an elective safe harbor for repairs. There is a separate allowance for each class of property under the MACRS system. Amounts up to the safe harbor are deductible; excess amounts must be capitalized. The proposed regulations do not include a de minimis rule allowing a taxpayer to deduct an amount paid below a certain dollar threshold for the acquisition of tangible personal property. The IRS is considering including such a rule in the final regulations.
2. Small Wares. Rev. Proc. 2000-12 allows for a deduction of small wares. Make sure you are taking advantage of this small wares deduction.
3. Tax Credits. Do not forget the various aspects of the Job Tax credits: WOTC, welfare-to-work, Empowerment Zones, etc. Examine them in detail and keep appropriate records.
4. Gift Cards. If your franchise business issues gift cards, the IRS has issued new rules that provide for safe harbors (allowing you to realize gift card income over a two-year period). This may seem conservative in light of the fact that many gift cards are never redeemed, but it beats taking it into account over one year.
5. Tip Reporting. If you are involved in tip reporting, the IRS has a new tip compliance guideline that should be reviewed with your tax advisor.
6. Manufacturing Credit. The IRS has issued guidance regarding the manufacturing deduction (IRC§ 199). In many cases this deduction will not apply to restaurants that are performing services for their own account; however, some of the inherent special rules and ability to use separate entities may benefit the restaurant industry or other franchise groups that are developing and performing manufacturing functions on behalf of other franchisees or entities.
7. Cost Segregation. Cost segregation is still a viable tax savings technique. The IRS recently issued very specific guidelines as to what they will and will not allow so there appears to be a great deal of certainty, particularly in the restaurant area as to the depreciation lives for assets associated with a building or leasehold.
8. Leases. Lease accounting issues need to be reviewed before year-end so you can assure yourself of the proper tax treatment. These issues involve amortization of a leasehold interest, rent holidays, and landlord and tenant incentives. Please note that this is one area where GAAP reporting and tax law diverge significantly.
Also, a recent IRS ruling addressed the sale/leaseback issue concerning interior leasehold improvements. If you have been dealing with this sale/leaseback issue, please refer to FSA 200217024.
9. Store Closures. If a store is closed, the previous position was that the remaining assets of a closed store could be written off. However, recently the IRS has taken the position that since the property has not been disposed of, there is no tax loss allowed (even though under FASB 144 the store closure would result in a financial loss). If you have closed stores or assets out of service, make sure you dispose of these assets before year-end.
10. Miscellaneous. There is always the tried and true approach to deferring income and accelerating deductions, so be careful between related parties and make sure assets are placed in service before year-end.
We hope these ideas are helpful. Next month’s column will address new employee incentives.
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