State and local tax (SALT) compliance in the hospitality and restaurant sectors always requires constant vigilance, especially lately as state legislatures turn to tax policy in response to the recent workplace changes in these industries. Although these new tax laws have their unique characteristics, the issues they address are common throughout the U.S., with state lawmakers routinely using tax solutions in other jurisdictions as models for their own legislation.
In 2023, SALT legislation impacting the hospitality and restaurant sectors tended to focus on these areas:
- Elective pass-through entity (PTE) taxation as a method to avoid limitations to the deductibility of state taxes
- Major tax overhauls in particular states, such as New Jersey and Minnesota, that affected corporate and business taxation
- The proliferation of food delivery services and other surcharges in the wake of industry changes spurred by the pandemic and consumer preferences
“There has been a continued focus on fiscal responsibility,” said Grant Thornton SALT Partner Chris Oatis. “For some states in a strong fiscal position, that has meant looking for ways to lower taxes and give back to businesses and residents of the state. Other states are looking to bridge their fiscal gap, in some cases due to relocated businesses and individuals, and so are retaining their current tax systems.”
Pass-through entity developments
"There has been a continued focus on fiscal responsibility. For some states in a strong fiscal position, that has meant looking for ways to lower taxes and give back to businesses and residents of the state. Other states are looking to bridge their fiscal gap, in some cases due to relocated businesses and individuals, and so are retaining their current tax system.”
The Tax Cuts and Jobs Act from late 2017, in general, lowered federal tax rates widely. But one area where the bill increased the burden on taxpayers was in establishing a $10,000 annual limit on the “SALT deduction,”— the amount taxpayers can deduct from their federal taxes based on the property, sales and income taxes they pay to state and local jurisdictions. The change was immediately unpopular in high-taxation states such as New Jersey and Connecticut, and after various attempts at workarounds, the most common response was for states to adopt an elective pass-through entity tax. By this method, pass-through businesses, which make up the majority of businesses in these sectors, can shift state taxes paid through individual taxpayers’ income onto the business entity for federal tax purposes.
The IRS released guidance agreeing with this workaround in 2020, and at the beginning of 2023, 30 states had already allowed elective pass-through entity taxation. In 2023, seven more states have enacted similar tax laws, including Hawaii, Indiana, Iowa, Kentucky, Montana, Nebraska and West Virginia.
Oatis cautioned that “significant consideration and evaluation should be undertaken prior to making a PTE tax election, since the election is made by the entity but impacts its owners. Consultation with the owners and an understanding of their personal tax situation in a given state is imperative,” he said, “and situations can arise where the election benefits one set of owners to the detriment of other owners.”
The PTE tax is elective in all states except Connecticut, where the tax is currently mandatory, though it also will change to being elective for tax years beginning on or after Jan. 1, 2024.
Significant state tax overhauls
Major tax legislation in Minnesota went into effect May 24, 2023, that contained several new and increased taxes on businesses for taxable years beginning after Dec. 31, 2022. Some of the provisions of the bill most directly affecting hospitality and restaurant businesses include:
- A reduction of the dividend received deduction from 80% to 50% when a recipient corporation owns 20% or more of the business’s stock, and 70% to 40% if the stock ownership is under 20%
- The net operating loss deduction is now capped at 70%, down from the previous 80%
- Taxpayers must include global intangible low-tax income (GILTI) as dividend income instead of considering it a subtraction adjustment
- The pass-through entity tax was amended to expand the number of qualifying entities for the election to those who have at least one owner who is a qualifying owner, but excludes publicly traded partnerships.
In New Jersey, legislation enacted in July 2023 makes major changes to its Corporation Business Tax (CBT), particularly on rules for combined group filing. The Section 163(j) interest deduction limit for business expenses is applied for combined groups as though the combined group files a consolidated return, and a worldwide combined group must include all members of the group, wherever located. A bright-line nexus standard used for CBT is established if annual receipts from New Jersey-based sources exceed $100,000 or the number of transactions in a year to New Jersey customers is 200 or more. As with Minnesota, GILTI is treated as dividend income, with all of foreign-derived intangible income (FDII) subject to the CBT.
In Tennessee, the state’s three-factor apportionment formula is being phased to a single-sales factor over a three-year period for corporate excise tax purposes. Per federal provisions in the TCJA, 100% bonus depreciation is being phased out, in 20%-per-year increments, for property placed in service after 2022, with bonus depreciation eliminated in 2027. Tennessee, which has historically decoupled from the 100% bonus depreciation, will conform to the less-than-100% bonus depreciation deductions starting in 2023.
“Restaurants that are looking to further expand their presence overseas will be more adversely affected domestically by these state tax law changes regarding GILTI and FDII,” Oatis said.
In addition, legislation concerning corporate income tax rates was passed in a number of states this year. Arkansas reduced the top corporate tax rate from 5.3–5.1% for tax years that began Jan. 1, 2023, while Nebraska also reduced its corporate income tax rate for tax years starting with next year’s tax year. Nebraska businesses, starting with tax years beginning on or after Jan. 1, 2025, can eliminate the tax rate on the first $100,000 of taxable income. The result is that one rate will apply to all income, that will be reduced yearly until it reaches 3.99% for tax years beginning in 2027. Meanwhile, Connecticut extended its 10% corporation business tax surcharge through the 2025 tax year. While New Jersey opted not to extend its 2.5% corporate surtax, New York has extended its increased 7.25% income tax rate and 0.1875% capital base tax rate for another three years.
Food delivery service taxation
Several states are realizing taxation opportunities in connection with food delivery services, which typically involves trying to identify taxation factors such as, the separation of fees on the receipt, assessing whether food prices change when delivered versus picked-up, and whether a pickup option is available. Generally, a restaurant would be responsible for a state or municipal delivery fee tax determination if the delivery was directly by the restaurant. Third-party delivery providers such as Grubhub, DoorDash and Uber Eats typically would be responsible for collecting the tax if they are a designated marketplace facilitator, though the definition of these may vary among states, a factor restaurants would want to monitor. A hybrid service provider — a company that merely takes orders placed on a restaurant’s website and coordinates delivery with a third-party delivery service — is generally not defined as a marketplace facilitator and thus the tax collection would be assumed by the restaurant.
Recently, Colorado imposed a fee of 27 cents (increased to 28 cents in July 2023) on all vehicle deliveries of one item or more that is subject to sales and use taxes. The tax applies to restaurants and retailers with annual sales in excess of $500,000. Minnesota enacted a 50-cent fee on items over $100 that takes effect next July 1. New York state also considered a 25-cent surcharge on deliveries, but this was not enacted.
“Food delivery services are an ever-evolving industry,” Oatis said, “and given the proliferation of providers and the evolution of their service offerings, this will continue be a complex and fluid tax area.”
Finally, while the IRS has put out recent guidance clarifying the application of Section 174, on the tax treatment of research and experimentation (R&E) expenses as amended in the TCJA, the change requiring companies to capitalize expenses over a five-year period (for domestic expenses) or 15-year period (for foreign expenses) has led many states to decouple from federal rules and allow R&E expenses to be deducted the year they are incurred. Georgia, Indiana, Mississippi and New Jersey all took such actions this year, and businesses in these states should pay close attention to how these changes may affect their filing considerations.
“While R&E expensing may not be as impacting to the restaurant and hospitality industry as it is on other industries,” Oatis said, “the continued development of restaurant industry-specific software will make Section 174 a recurring consideration.”
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