Businesses are eyeing accounting maneuvers to get around a glitch in the 2017 tax act as lawmakers have failed to pass a fix more than two years after the law’s enactment.
The drafting mistake blocked brick-and-mortar companies like restaurants and retailers that make interior renovations from a major business benefit in the law—the ability to fully and immediately write off certain capital expenses, rather than doing so piecemeal over time. In some cases, it makes those renovations more expensive than they would’ve been before the law went into effect.
As it’s grown increasingly apparent that a correction isn’t happening anytime soon, businesses are considering two existing ways to get a piece of the tax benefit they missed out on.
Some are conducting a study of past construction projects, in which certain costs are carved out for other deductions allowed by the tax code. Another option is a safe harbor most businesses already opted into in 2015, which allows a 75% write-off for remodeling work with a quick turnaround.
Early in 2018, businesses expected lawmakers to correct the error “any minute now,” but by the middle of last year, more businesses started turning to one of the two workarounds, said Lisa Haffer, a CPA and tax partner at BDO USA LLP.
Neither route can fully replace the benefit, which is known as 100% bonus depreciation or full expensing. While it’s not such a big deal to big businesses, it is a highly coveted financing mechanism for smaller ones.
As recently as the fourth quarter, RILA, McDonald’s Corp., the parent of Dunkin Donuts and Baskin Robbins, Verizon Communications Inc., Lowes Cos. Inc., Best Buy Co. Inc., and many others were lobbying to fix the error.
One alternative for businesses is what’s called a cost-segregation study. After conducting an engineering-based evaluation of the costs of construction projects, they carve out different categories of property that may be eligible for full expensing, a complete current-year write-off of the cost. For a restaurant, that might include new woodwork at the bar, decorative lighting, or restaurant-specific plumbing and ductwork, Haffer said.
For a hotel, that might include a new front desk, a light-dimming system, or ballroom renovations, said Joseph Strickland, a registered architect and managing director of Mazars USA’s cost-segregation practice. He said he hasn’t seen a spike in requests for these studies, but that there’s certainly been more interest from businesses looking to get around the error, known as the “retail glitch.”
“I think the restaurants that call us now—the traditional cost-segregation study, that’s the only hope,” Strickland said.
It’s not quite the same as 100% bonus depreciation, however, since not every construction cost will be eligible. And states might have different laws governing depreciation, so the tax breaks at the federal level may not match those at the state level. That could worsen what is already an accounting headache.
Cost segregation studies are “certainly something clients are exploring,” said Ellen McElroy, a partner at Eversheds Sutherland LLP in Washington. But cost-segregation studies aren’t free, and if the mistake in the law is corrected, the business would have to go back and do it all over again.
“It is time and an expense to the company, and there are consequences that would have to be revised when the legislation is enacted,” said McElroy. A former IRS official, she expects the agency not to enforce the error, but others aren’t as optimistic and are examining their options.
Some companies have chosen to fully write off those costs anyway in the hope that lawmakers will pass a correction, or the IRS will tell its auditors to stand down, though McElroy said the number of businesses deciding to take this route is likely small.
Treasury declined to address the error last year, punting the issue to Congress. Lawmakers such as Sen. Pat Toomey (R-Pa.) have introduced fixes (S. 3296), though none have moved forward. Any technical corrections to the tax law will be subject to careful negotiation, with Democrats hoping to check off other priorities in exchange.
Treasury Secretary Steven Mnuchin said during a congressional hearing Tuesday that he and House Ways and Means Committee Chairman Richard Neal (D-Mass.) have been talking about a path to fixing the error.
“This is not a partisan issue,” Mnuchin said.
Another option can be found in 2015 IRS guidance allowing a 75% write-off for remodeling done within the span of 21 days. If a Burger King franchise owner needs to update stores in line with some new company standard or aesthetic, for instance, and can do it in three weeks, the franchisee can write off 75% of the costs without having to show the IRS the receipts.
Haffer noted that the franchisee in such a case might benefit, though they must prove it took 21 days or less and must have an audited financial statement.
Many retailers and restaurants opted into this approach in 2015 and are still able to use it, tax and industry professionals said, so it hasn’t experienced the same uptick in interest that cost-segregation studies have.
—With assistance from kaustuv Basu.