The Covid-19 pandemic presented numerous obstacles for the restaurant and hospitality industry. With the support of government related programs such as the Payroll Protection Program (PPP), Employee Retention Tax Credits (ERTC), Economic Injury Disaster Loans (EIDL), and state-related grants and credits, most operators were able to continue or revitalize their businesses. Having an entrepreneurial mindset, many business owners were able to prevail over these obstacles and are now able to expand their operations. As you think about expanding and growing, here are several considerations that are relevant to today’s market:
- Formation of new entities – When opening a new restaurant location, you should consider forming a new entity if this venture will have (1) different ownership structure (2) a separate lease, or (3) operations in a different state. Restaurateurs predominately choose the LLC structure to set-up new entities, which is easy to form and allows for flexibility on the allocation of income and liabilities.
- Intellectual Property – As you begin to expand operations and open new locations, it is important to determine if there is any intellectual property related to your concept or brand and who has rights to it. Intellectual property generally includes patents, trademarks, copyrights, and trade secrets. For restaurants, it might include the restaurant name, certain recipes, slogan, or logo. In the future, you may want to license your concept to a third party, therefore it’s important to separate this asset from the operating entity. For protection, the intellectual property should exist in its own legal entity. This will also allow you to negotiate a potential strategic transaction that includes, or excludes, this asset.
- Leases – During the pandemic, many operators renegotiated lease terms with their landlords. Most were able to benefit from rent deferrals, discounts, or abatements, but others agreed to rent based on percentage of sales or a hybrid between percentage and fixed monthly rent. This seemed like an ideal situation when sales were significantly lower, but in hindsight, some have regrets on the re-negotiated terms. Given today’s state of the economy, operators should try to stay away from percentage rents, which usually are in addition to your fixed rents. The best scenario is to find a lease with a fixed monthly rent so you can budget effectively. In certain metropolitan areas you may be able to get a lease where it is heavily discounted as compared to pre-Covid market values. The target range for rent is between seven percent to ten percent of your total revenue.
- Deductibility of Meals – Typically a business deduction for any food or beverage is limited to 50 percent. Now, businesses are allowed to claim a 100 percent business meal deduction on food or beverages provided by a restaurant for the period beginning January 1, 2021, through December 31, 2022. This temporary exception was passed to help the hospitality industry recover from the pandemic. This is set to expire January 1, 2023, therefore, it is important to budget accordingly as this can impact revenue and your plans for future growth. The tax deduction will revert to a 50 percent business meal deduction as of January 1, 2023.
- Depreciation - The Tax Cut and Jobs Act (TCJA) increased the bonus deprecation from 50 percent to 100 percent for qualifying assets. 2022 is the final year in which taxpayers can immediately deduct 100 percent of their qualifying assets. Beginning January 1, 2023, the rate for bonus depreciation will be reduced to 80 percent, followed by a reduction in 2024 to 60 percent, a reduction in 2025 to 40 percent, and reduced to 20 percent in 2026. The deduction will expire on January 1, 2027 – unless congress amends the law. Generally, property eligible for bonus depreciation is property with a recovery period of less than 20 years, such as machinery, equipment, and furniture, as well as qualified improvements. This is an opportunity for businesses to consider accelerating capital expenditures into 2022 to reap the benefits of the full deduction in one year. In addition, taxpayers will need to consider the state conformity to the federal bonus rates annually.
John Maxwell said, “Change is inevitable. Growth is optional”. Rapid changes brought about by the Covid-19 pandemic were unavoidable for all business owners, but how they will continue to move forward is now up to them. Carefully consider the above items as you think about growth. If you have any questions, please reach out to Krenar Mejia at firstname.lastname@example.org or your Citrin Cooperman Restaurants & Hospitality Practice advisor.
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