By Joseph Ecuyer, DominickSchirripa
Substantial tax breaks underthe 2017 tax act, such as a reduced corporate tax rate, enhanced depreciationprovisions, and a new deduction for so-called pass-through entities such aspartnerships, will likely mean lower income tax bills for much of the hotelindustry. But the act’s repeal of the entertainment and expense deduction mightdecrease customer spending, which could threaten industry profits.
From the standpoint of thehotel 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 weresubject to the AMT in prior years will be able to use the prior year minimumtax 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 andresidential rental property.
• Provides a special 20% deduction to owners of pass-through entities such aspartnerships, S corporations and LLCs.
Enhanced Expensing andBonus 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 forinflation).
The act increases theexpensing limitation and the phaseout amount, and expands the types of propertysubject to the election. The act allows businesses to expense up to $1 millionsubject to a phaseout if the costs exceed $2.5 million (both indexed forinflation).
The act also permits theexpensing of improvements to roofs; heating, ventilation, and air-conditioningproperty; fire protection and alarm systems; and security systems.
Before the act, taxpayerswere generally not permitted to expense the full cost of acquiring property forbusiness use the year they purchase it. Instead they were required to takedepreciation deductions over the “useful life” of the property. For certainproperty, taxpayers were permitted additional first-year depreciation of 50% ofthe adjusted basis of the property the year it is placed in service, if placedin service before January 1, 2020. If the property is manufactured or producedby the taxpayer, the manufacture or production was required to begin beforeJanuary 1, 2020.
The act allows taxpayers toimmediately expense 100% of the cost of qualified property acquired and placedin service after September 27, 2017, and before January 1, 2023. The actfurther proposes to incrementally phase down the expensing though2026—taxpayers will only be able to immediately expense 20% of the cost ofqualified property acquired and placed in service after December 31, 2026. Theincremental phase down is one year longer for properties with longer productionperiods. The act also expands the property that is eligible for this additionaldepreciation to include used property.
Taxpayers will be allowedto elect 50% expensing in lieu of 100% expensing for qualified property placedin service during the first tax year ending after September 27, 2017.
The act eliminates theseparate definitions of qualified leasehold improvement, qualified restaurantproperty, and qualified retail improvement property, and provides a general15-year recovery period for qualified improvement property and a 20-yearalternative depreciation system (ADS) recovery period for such property. The provisionalso requires a real property trade or business electing out of the limitationon the deduction for interest expense to use ADS to depreciate any of itsnonresidential real property, residential rental property, and qualifiedimprovement property. The ADS depreciation period on nonresidential realproperty and qualified improvement property is 40 years. The act reduced theADS depreciation period for residential rental property to 30 years. Given thedifferences in recovery periods, this election will require projection modelingof the tradeoff between interest expense and depreciation.
Reform of Taxation ofPass-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 ofbusiness income earned through pass-through entities. The effect of the changeswill be to move such income away from being taxed under the individual incometax brackets of owners (which typically means taxation at higher marginalrates) towards a system more on par with the lower corporate rate included inthe legislation.
The act allows for a 20%deduction for taxpayers with qualified income (generally, domestic businessincome derived from an active business enterprise plus investment interest, andcertain gains). Taxpayers with taxable income exceeding $157,400 ($315,000 formarried joint filers) are subject to certain limitations on the deductioncoupled with a phase-in of the limits.
Repeal of Entertainment ExpenseDeduction
Obviously, the repeal ofthe meals and entertainment expense deduction could hurt the hotel industry asemployers may look to limit the expense accounts of employees.
Prior to the act, if ataxpayer established that entertainment expenses were directly related to (orassociated with) the active conduct of its trade or business, the deductiongenerally was limited to 50% of the amount otherwise deductible.
The act disallowsdeductions for entertainment, amusement, or recreation activities under allcircumstances. In addition, the act disallows a deduction for expensesassociated with providing any qualified transportation fringe to employees ofthe taxpayer, and except as necessary for ensuring the safety of an employee,any expense incurred for providing transportation (or any payment orreimbursement) for commuting between the employee’s residence and place ofemployment.
Taxpayers may still,generally, deduct 50% of the food and beverage expenses associated withoperating their trade or business (e.g., meals consumed by employees on worktravel). For amounts incurred and paid after December 31, 2017 and untilDecember 31, 2025, the act expands this 50% limitation to expenses of theemployer associated with providing food and beverages to employees through aneating facility that meets the requirements for de minimis fringes and for theconvenience of the employer. Such amounts incurred and paid after December 31,2025 will not be deductible.
While the repeal of theentertainment and expense deduction is likely to have a negative impact on thehotel industry, its severity may be lessened by other provisions, such as lowertax rates that might spur consumer spending. Overall, the 2017 tax act islikely to help reduce the hotel industry’s income tax bill, if not raise itsbottom line.
After years in privatepractice in New Orleans in both the tax and ERISA areas, Joe Ecuyer joinedBloomberg Tax in 2005 where he is currently a Tax Law Editor in the U.S. IncomeGroup. He works mainly on issues related to personal and business income,deductions and credits. Joe earned a B.S. in Accounting from Louisiana StateUniversity, a J.D. from the University of Michigan Law School, and an LL.M. (inTaxation) 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 TaxCourt
Dominick Schirripajoined Bloomberg Tax in 2014 as a Tax Law Editor in the Estates, Gifts, andTrusts group, and was named Managing Editor of the group in December 2017.Prior to joining Bloomberg, Dominick was in private practice with a focus oncorporate taxation and business planning. Prior to that, Dominick clerked forthe Hon. Carolyn P. Chiechi of the United States Tax Court. Dominick has hisA.B. (in Economics and Government) from Cornell University, his J.D. (withconcentrations in Taxation and Constitutional Law) from the Benjamin N. CardozoSchool of Law, and his LL.M. (in Taxation) from New York University School ofLaw.ed States Tax Court.