Maximizing Your Tax Savings: Strategies Every F&B Business Owner Should Consider
Marcum’s inaugural Food and Beverage (F&B) Survey1 revealed a year of industry growth in 2022. Despite this good news, however, many F&B companies left dollars on the table by overlooking potentially lucrative tax incentives that go directly to the bottom line. Below is an overview of several that every F&B company should thoroughly consider in collaboration with their tax advisors.
R&D Tax Credit
The Research and Development (R&D) tax credit is a subsidy available to companies that invest in improving processes and adding value to their products.
When many people hear the term “research and development,” they think of scientists in white lab coats developing life-saving vaccines. However, certain processes that your business has been utilizing to increase efficiency and/or quality might qualify for more than admiration; they may be a qualified expense that could reduce your tax liability through a dollar-for-dollar tax credit. This might include, for example:
- Coming up with new ways to reduce scrap and improve efficiency
- Streamlining the design of food and beverage packaging to reduce waste or production expense
- Experimenting with developing new recipes, ingredients, or products that meet the changing needs of consumers
Consumers are demanding products that are healthier and more sustainable – whether that means finding alternative sweeteners or proteins or developing organic or gluten-free options. The R&D tax credit is a bonus for companies stepping up to meet this demand.
To determine whether your business has qualified research expenses for the R&D tax credit, it must meet a four-part test. First, the research must have a permitted purpose: that is the development of a new or improved business component such as a food product, process, packing method, or recipe. Second, there must be technical uncertainty about the feasibility of achieving the desired result that could be eliminated by the research activities. For example, a restaurant may conduct research on how to reduce the sugar content in a dessert while maintaining its taste and texture. Third, the research must involve a process of experimentation to identify this technical uncertainty and come up with alternatives. This may include testing different ingredients, processes, or equipment. Finally, the research must be technological in nature, meaning that it must rely on principles of physical, biological, engineering, or computer sciences. For instance, a brewery may conduct research on how to optimize the fermentation process to produce a new type of beer with unique flavors and aromas. By meeting these criteria, businesses can confidently claim the R&D tax credit for qualified research expenses and continue to invest in innovative and impactful research activities.
No two businesses are the same. It is essential that your tax professional understands your company’s operations so they can help you determine how your organization can best take advantage of the R&D tax credit.
FICA Tip Credit
The FICA tip credit is a tax benefit available to F&B employers with employees who receive tips (e.g., restaurants, bars, country clubs, etc.). It allows employers to claim a credit for Social Security and Medicare taxes (7.65% in 2023) that they pay on employee tips exceeding those treated as wages, resulting in a reduction in their overall tax liability.2
Note that automatic gratuity and assessed service charges are not considered tips because they are mandatory rather than voluntary. The IRS treats those service charges as taxable wages.
For example, say restaurant server Tom earns $3.15 per hour in wages and receives an average of $7 per hour in tips. The difference between the $5.15-per-hour minimum wage and the $3.15 per hour Tom actually earns in wages is $2. For purposes of calculating the restaurant’s FICA tip credit, this $2 is deducted from the $7/hour Tom collects in tips. Assuming a 7.65% FICA tax rate, the employer can claim a FICA tip credit of $0.383 per hour ($7 – $2 = $5 x 7.65%).
For a full-time employee working 40 hours per week, this would result in an annual tax credit of approximately $800. While that may seem insignificant, the credit can accumulate significantly for businesses with larger staffs. For a team of 20 employees similarly situated, and assuming the same hypothetical facts and circumstances above, the FICA tip credit for the year would grow to $16,000 to offset the business’s income tax liability.
Cost Segregation Study
A cost segregation study is an engineering-based analysis that identifies and reclassifies assets in real properties for tax purposes. It separates the property’s assets into shorter recovery periods, typically 3, 5, 7, or 15 years, rather than the 27.5 or 39-year depreciation periods. This allows taxpayers to accelerate depreciation deductions and reduce tax liability in the earlier years of ownership.
For F&B businesses, a cost segregation study can be particularly valuable because of the high cost of assets such as equipment, kitchen fixtures, and building improvements. By identifying and reclassifying these items as shorter-lived assets, F&B businesses can claim a larger deduction for depreciation sooner in the lifecycle of those assets, resulting in a reduction in tax liability and an increase in cash flow.
For example, a restaurant owner purchases a building for $2 million. Typically, the entire building would be classified as a 39-year asset and would be depreciated over that period. This would result in an annual depreciation expense deduction of $51,282. However, with a cost segregation study, it may be determined that a portion of the building – such as the kitchen equipment, lighting fixtures, or decorative finishes – can be reclassified as 3-, 5-, 7-, or 15-year assets. This would allow these assets to be depreciated over a much shorter period, resulting in a higher annual depreciation deduction.
If $500,000 of the building’s value can be reclassified as 3-, 5-, 7- or 15-year assets, the restaurant owner could deduct an additional $20,000 to $87,000 per year, depending on the assets’ classification. This deduction could also be higher if you factor in any special depreciation methods that may apply. This results in significant tax savings, as the restaurant owner can deduct more of the building’s cost in the early years of ownership, when the tax benefits are most valuable.
It’s important to note that not all F&B businesses will benefit from a cost segregation study. Generally, businesses that have recently acquired or constructed assets with a value of $500,000 or more or have made significant renovations or improvements to existing assets, may benefit from a cost segregation study. The specific benefits that could be realized will depend on individual circumstances.
In addition to the immediate tax benefits, F&B businesses that undertake a cost segregation study can also benefit in the long run by improving their financial position. The increased cash flow that results from the accelerated depreciation deductions can be reinvested in the business, allowing for expansion, renovation, or the acquisition of new assets. This can lead to increased revenue and profitability over time.
Work Opportunity Tax Credit
The Work Opportunity Tax Credit (“WOTC”) is a federal tax credit available to employers that hire individuals from certain targeted groups that historically have faced significant barriers to employment. The goal of the credit is to encourage employers to hire individuals who may have difficulty finding employment, such as veterans, ex-felons, individuals receiving certain government benefits, etc.
For the F&B industry, this tax credit can be particularly beneficial, as many restaurant and hospitality businesses hire employees who may qualify for the credit. The credit can provide a dollar-for-dollar reduction in an employer’s federal income tax liability, and the amount of the credit can range from $1,200 to $9,600 per eligible employee, depending on the target group the employee belongs to and the number of hours they work.
Below are just a few examples of how a restaurant could take advantage of the WOTC for hiring individuals who perform more than 400 hours of services:
- Hiring a qualified veteran: If a restaurant hires a veteran who is certified as being entitled to compensation for a service-connected disability, and has been unemployed for at least six months, the restaurant may be eligible for a tax credit equal to 40% of the employee’s first-year wages, up to a maximum credit of $9,600.
- Hiring a qualified ex-felon: If a restaurant hires an ex-felon who has been convicted of a felony within the past year or is currently on probation or parole, the business may be eligible for a tax credit equal to 40% of the employee’s first-year wages, up to a maximum credit of $2,400.
- Hiring a qualified individual receiving SNAP benefits: If a restaurant hires an individual between 18 and 39 years old who has been receiving SNAP (Supplemental Nutrition Assistance Program) benefits for at least six months, the business may be eligible for a tax credit equal to 40% of the employee’s first-year wages, up to a maximum credit of $2,400.
- Hiring qualified summer youth employees: If a restaurant hires individuals who are 16 or 17-years-old on May 1 and reside in an empowerment zone, the business may be eligible for a tax credit of 40% of wages paid during any 90-day period between May 1 and September 15, up to a maximum credit of $1,200.
These are just a few examples of new hires who may qualify for the WOTC.3 Several other target groups could also be eligible for the credit, which can be discussed in further detail with your tax professional. For F&B businesses looking to save on their tax bills and provide job opportunities for individuals facing significant barriers to employment, the WOTC can be a valuable tax incentive.
General Accounting Methods
There are a few smaller tax credit opportunities for F&B companies that could add up to potentially large tax savings in the long run.
Smallware such as dishes, glassware, silverware, bar supplies, food prep utensils, and many more are often treated as inventory or a depreciable asset; that is, they are capitalized and deducted when used or consumed. The cost of these items, however, can be deducted when the inventory is received – allowing for an immediate tax benefit.
Under the Uniform Capitalization Rules (UNICAP), certain direct and indirect costs are required to be capitalized to inventory. Small businesses (average gross receipts less than $25 million) are eligible to deduct some of these costs immediately, rather than capitalizing them.
Package design costs generally must be capitalized, using one of several methods to account for these costs. Some methods require amortization of the capitalized costs over 4 or 5 years. With IRS consent, a taxpayer can use the capitalization method and include the year the product was manufactured on the label. When subsequent years’ labels are in use, the cost of the previous design can be deducted upon the disposition, abandonment, or modification of that design. This would accelerate the deduction, so the tax benefit can be realized sooner.
Gift cards and other advanced payments are often included in income in the year the payments are received. Accrual-method taxpayers have the option to defer recognition of this income until the tax year following the year the advanced payments are received, if the gift cards are not yet redeemed.
Accrued bonuses, vacation, sick, and severance pay can be deducted in a tax year if the benefit was paid to the employee within 2.5 months of year-end. For example, if a calendar-year taxpayer has a fixed accrued vacation balance at the end of year 2022 that was paid out before March 15t, 2023, the taxpayer has the option to deduct the amount paid before March 15 on their 2022 tax return, instead of the 2023 return. This option can be utilized to accelerate deductions if the 2022 tax year is expected to have higher income than 2023.
These are just a few additional opportunities that F&B businesses have at their disposal to realize potential tax benefits. These opportunities will not apply to every business, and some may not find these methods beneficial for their goals. Your tax professional can work with you to determine the best option for your specific circumstances.
The tax incentives outlined above are just some of the opportunities F&B businesses have at their fingertips for potential tax savings. There is no one-size-fits-all approach when it comes to a businesses’ taxes – especially in an industry as dynamic and rapidly changing as food and beverage. Consult your Marcum F&B tax professional about tax incentives that may benefit your business.
- “§ 45B Credit for portion of employer social security taxes paid with respect to employee cash tips.” Checkpoint, Thomson Reuters, https://checkpoint.riag.com/.
- “§51 Amount of credit” Checkpoint, Thomson Reuters, https://checkpoint.riag.com/.