Tax planning for franchisors and franchisees: 2023 year-end strategies
Phaseout of bonus depreciation, placing assets in service, and cost segregation
The 2017 Tax Cuts and Jobs Act (TCJA) enabled businesses to accelerate 100% of the depreciation deduction on new and used assets placed in service by the end of 2022. The bonus depreciation deduction for 2023 is 80% for assets placed in service prior to the end of the year. For tax year 2024, the deduction will be 60%, and it will continue to decline by 20% annually until it phases out after Dec. 31, 2026.
If you’ve purchased qualified assets, such as software or furniture, or made leasehold improvements, you’ll want to get them in service by December 31 so you can take the 80% bonus depreciation deduction for 2023; just purchasing the asset does not qualify for the deduction.
One way to increase the value of bonus depreciation is to use a cost segregation study to accurately categorize components of buildings into asset classes that have recovery periods of 20 years or less, making them eligible for whatever bonus depreciation percentage is available in the year placed in service. Consider reaching out to your tax advisors if you’ve recently purchased a building, made improvements, or expanded.
Federal tax exemption of pooled advertising funds
Pooled advertising funds are common in the franchise space, and contributions to the fund from franchisee stakeholders are exempt from federal tax if certain requirements are met. In other words, since the funds are held in trust, they aren’t considered payment for products or services — even if the money is collected one year and spent the next. Takeaway:
If you use or have recently set up a pooled advertising fund for franchise advertising, you’ll want to ensure the structure of your fund meets the criteria to be eligible for the federal (and perhaps state) tax exemption in 2023.
Employee retention credit (ERC) pause and claim withdrawal
In September, the IRS announced it would pause processing ERC claims through December 31 and established an ERC claim withdrawal process for taxpayers who might have filed improper claims. Taxpayers must meet several criteria to qualify for withdrawal. If you have concerns about your ERC claim, consult your tax advisor — even if you originally used an ERC marketing firm or other third party to file it. Your tax professional can help you assess the validity of your claim and, if warranted, recommend appropriate next steps to correct or withdraw the original filing. Taxpayers deciding and meeting the criteria to withdraw must withdraw the entire claim, and the IRS will treat it as if the taxpayer never filed a claim for the purposes of applying civil penalties and interest.
Other tax credits
FICA tip credit
As in previous years, franchise restaurant owners are eligible to claim a credit for the portion of FICA and Medicare tax they pay on employee-reported tip income. This dollar-for-dollar credit applies against the employer’s federal income tax bill.
Work Opportunity Tax Credit (WOTC)
Employers who hire workers from targeted groups may qualify for a tax credit of a portion of wages paid to qualified employees. The WOTC is set to expire at the end of the 2025 tax year. Reach out to your payroll provider to help arrange proper documentation to certify qualified employees and calculate the eligible credit.
Opportunity zone funds and Empowerment Zone Employment Credits
Both opportunity zone funds and Empowerment Zone Employment Credits are incentive programs designed to spur investment in and revitalization of distressed communities. Legislation to update the Opportunity Zone Program has recently been proposed and, if passed, will include extension of the investment period and deferral of capital gain recognition to Dec. 31, 2028, as well as introduce changes in reporting requirements.
The Empowerment Zone Employment Credit offers employers in designated zones a credit of up to 20% of the first $15,000 of annual wages paid to workers who reside in the zone. The credit also applies to payments for services performed by residents. Current empowerment zone designations are in place until Dec. 31, 2025.
Be sure you’re fully utilizing all credits and incentives for which your business is eligible.
Section 174: Amortization of research and experimental expenditures
In September, the IRS issued a notice to address taxpayer questions about Section 174 capitalization requirements for research and experimentation, or R&E, expenses. In the past, businesses could deduct these expenses under Section 174 in the year they were incurred. This changed at the start of 2022, when a TCJA provision went into effect. Now, R&E expenses for U.S.-based research are required to be capitalized and amortized over five years, and over 15 years for foreign expenses.
The TCJA changes to Section 174 also broadened the definition of software development, even if the development might not have met the earlier R&E definition.
Franchises that have developed software, or developed a customer app for example, should consult with their tax advisor about whether Section 174 might now apply.
State and local tax pass-through entity tax (PTET) and deduction
With the TCJA came a $10,000 cap on state and local tax deductions on an individual’s personal return. Many states since have begun to allow flow-through entities to make an election to pay state taxes at the entity level (S corporation or partnership). The pass-through entity tax (PTET) lets businesses deduct state and local tax paid for federal tax purposes. This allows the full deduction to flow from the entity to the individual’s personal tax return.
Each year, more states are instituting a PTET, but the rules and election requirements vary widely. Look at the rules in your state and talk with your tax professional to determine whether the PTET is an option for your business and, if so, how and when to elect.
Franchise businesses with activity in multiple states also should review their nexus determinations, apportionment, and sales and use tax exposures on an annual basis.
Additional year-end issues and opportunities to consider
Multiple locations and large amounts of customer data, among other factors, can pose cybersecurity risks for franchise businesses. To protect your organization, strengthen your cybersecurity program with three high-impact actions: Conduct a cyber risk assessment, develop incident response plans, and ensure payment card industry (PCI) compliance. These aren’t the only necessary activities of course, but they can provide a strong foundation and return on investment.
Assess space and real estate needs
If you have plans to expand the footprint of your franchise business in 2024 and beyond, consider your existing and future real estate and construction needs. Review leases; investigate available government incentives, including the tax credits covered earlier; initiate site selection and project budgeting and scoping. Operating in the right space is critical to franchise success, so assess your needs and plan ahead.
As you continue your year-end 2023 tax planning — and look ahead to 2024 — keep these items on your radar. Be sure to discuss your specific situation with tax professionals who understand your unique individual and business circumstances.