By Joseph Ecuyer, Dominick Schirripa
Substantial tax breaks under the 2017 tax act, such as a reduced corporate tax rate, enhanced depreciation provisions, and a new deduction for so-called pass-through entities such as partnerships, will likely mean lower income tax bills for much of the hotel industry. But the act’s repeal of the entertainment and expense deduction might decrease customer spending, which could threaten industry profits.
From the standpoint of the hotel industry, there is much to like about the new tax law. The act:
• Replaces the previous progressive rate structure and its top tax rate of 35% with a flat rate of 21% for tax years beginning after December 31, 2017.
• Eliminates the corporate alternative minimum tax—corporations that were subject to the AMT in prior years will be able to use the prior year minimum tax credit to offset their tax liability over the next few tax years.
• Allows temporary 100% expensing for certain business assets.
• Enhances depreciation deductions for nonresidential real property and residential rental property.
• Provides a special 20% deduction to owners of pass-through entities such as partnerships, S corporations and LLCs.
Enhanced Expensing and Bonus Depreciation Deductions
The immediate expensing of assets will provide a benefit to all businesses, including hotels. Current law permits businesses to elect to expense up to $500,000, subject to phase out if the costs exceed $2 million (both indexed for inflation).
The act increases the expensing limitation and the phaseout amount, and expands the types of property subject to the election. The act allows businesses to expense up to $1 million subject to a phaseout if the costs exceed $2.5 million (both indexed for inflation).
The act also permits the expensing of improvements to roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
Before the act, taxpayers were generally not permitted to expense the full cost of acquiring property for business use the year they purchase it. Instead they were required to take depreciation deductions over the “useful life” of the property. For certain property, taxpayers were permitted additional first-year depreciation of 50% of the adjusted basis of the property the year it is placed in service, if placed in service before January 1, 2020. If the property is manufactured or produced by the taxpayer, the manufacture or production was required to begin before January 1, 2020.
The act allows taxpayers to immediately expense 100% of the cost of qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. The act further proposes to incrementally phase down the expensing though 2026—taxpayers will only be able to immediately expense 20% of the cost of qualified property acquired and placed in service after December 31, 2026. The incremental phase down is one year longer for properties with longer production periods. The act also expands the property that is eligible for this additional depreciation to include used property.
Taxpayers will be allowed to elect 50% expensing in lieu of 100% expensing for qualified property placed in service during the first tax year ending after September 27, 2017.
The act eliminates the separate definitions of qualified leasehold improvement, qualified restaurant property, and qualified retail improvement property, and provides a general 15-year recovery period for qualified improvement property and a 20-year alternative depreciation system (ADS) recovery period for such property. The provision also requires a real property trade or business electing out of the limitation on the deduction for interest expense to use ADS to depreciate any of its nonresidential real property, residential rental property, and qualified improvement property. The ADS depreciation period on nonresidential real property and qualified improvement property is 40 years. The act reduced the ADS depreciation period for residential rental property to 30 years. Given the differences in recovery periods, this election will require projection modeling of the tradeoff between interest expense and depreciation.
Reform of Taxation of Pass-Through Entity Business Income
Some hotels are small businesses and are operated as pass-through entities, such as partnerships, LLCs or S corporations. The act alters the taxation of business income earned through pass-through entities. The effect of the changes will be to move such income away from being taxed under the individual income tax brackets of owners (which typically means taxation at higher marginal rates) towards a system more on par with the lower corporate rate included in the legislation.
The act allows for a 20% deduction for taxpayers with qualified income (generally, domestic business income derived from an active business enterprise plus investment interest, and certain gains). Taxpayers with taxable income exceeding $157,400 ($315,000 for married joint filers) are subject to certain limitations on the deduction coupled with a phase-in of the limits.
Repeal of Entertainment Expense Deduction
Obviously, the repeal of the meals and entertainment expense deduction could hurt the hotel industry as employers may look to limit the expense accounts of employees.
Prior to the act, if a taxpayer established that entertainment expenses were directly related to (or associated with) the active conduct of its trade or business, the deduction generally was limited to 50% of the amount otherwise deductible.
The act disallows deductions for entertainment, amusement, or recreation activities under all circumstances. In addition, the act disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, and except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.
Taxpayers may still, generally, deduct 50% of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel). For amounts incurred and paid after December 31, 2017 and until December 31, 2025, the act expands this 50% limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets the requirements for de minimis fringes and for the convenience of the employer. Such amounts incurred and paid after December 31, 2025 will not be deductible.
While the repeal of the entertainment and expense deduction is likely to have a negative impact on the hotel industry, its severity may be lessened by other provisions, such as lower tax rates that might spur consumer spending. Overall, the 2017 tax act is likely to help reduce the hotel industry’s income tax bill, if not raise its bottom line.
After years in private practice in New Orleans in both the tax and ERISA areas, Joe Ecuyer joined Bloomberg Tax in 2005 where he is currently a Tax Law Editor in the U.S. Income Group. He works mainly on issues related to personal and business income, deductions and credits. Joe earned a B.S. in Accounting from Louisiana State University, a J.D. from the University of Michigan Law School, and an LL.M. (in Taxation) from New York University School of Law. After graduating from NYU, Joe worked as an Attorney-Advisor for Judge David Laro of the United States Tax Court
Dominick Schirripa joined Bloomberg Tax in 2014 as a Tax Law Editor in the Estates, Gifts, and Trusts group, and was named Managing Editor of the group in December 2017. Prior to joining Bloomberg, Dominick was in private practice with a focus on corporate taxation and business planning. Prior to that, Dominick clerked for the Hon. Carolyn P. Chiechi of the United States Tax Court. Dominick has his A.B. (in Economics and Government) from Cornell University, his J.D. (with concentrations in Taxation and Constitutional Law) from the Benjamin N. Cardozo School of Law, and his LL.M. (in Taxation) from New York University School of Law.ed States Tax Court.