Tax Code Review Could Impact Hospitality Industry
by
Member of the Firm
President George W. Bush is starting off his second term with a bang. He has proposed a number of significant changes to the way Congress and the American people do business-not the least of which is a reform of social security and a review of the tax code. In his first term, the president successfully ushered five major tax bills through Congress in four years. Looking toward his second term, the president established a panel to develop programs for tax simplification and reform. Unlike past suggestions, this panel's recommendation could result in fundamental changes in the nation's tax laws.
However, not everyone is in favor of major alterations-particularly those whose industries are directly impacted by significant changes. The last change of the magnitude being discussed occurred in 1986. At that point, Congress eliminated a number of deductions and reduced the tax rate to ensure that taxpayers were not in worse shape than they were when the process started. The hospitality industry was one industry that did not make out very well with the changes. The meals and entertainment deduction was significantly limited (remember the two-martini lunch?), and the deductibility of club dues (including the airline clubs) was eliminated. Then, to make matters worse, the tax rate began to creep back up but the deductions did not come back.
During the presidential election, George W. Bush thought that replacing the federal income tax with a national sales tax was a good idea. The last time a national sales tax was discussed, it was considered to be too complicated and left too many questions unanswered. This time the tax reform panel has been given its marching orders; the president wants to see results. The panel should come up with revenue-neutral policy options for reforming the tax code. At this point, recommendations are expected across the board.
The tax reform panel was not appointed until January and is supposed to be finished by July 31, 2005. Then the real work and debates will begin. Congress will hold hearings and try to come up with legislation, assuming it finds time with the other issues on its plate. The recommendations need to simplify the tax laws, share the burden and benefits of the federal tax structure in a progressive manner, and promote economic growth and job creation.
On top of all of this, it still must raise $2.2 trillion ($967 billion of which comes from individuals). The president is not waiting for the report, however. The latest budget contains nearly $1.2 trillion in lower taxes over 10 years, mainly from making his first term tax cuts permanent.
As previously stated, the Bush administration was able to get five major tax bills enacted during his first four years in office. The two enacted in 2004 do have an impact on the hospitality industry. The welfare-to-work and work opportunity tax credits (WOTC) were extended for wages paid or incurred for qualified individuals starting work after 2003 and before 2006. These credits basically reward employers for hiring economically disadvantaged individuals.
In many localities, the lodging industry is one of the principal employers of this economic class. If you do not take advantage of the credits, you may be missing something since the WOTC can run as high as $2,400 for each employee and the welfare to work credit is $8,500 per employee.
The other tax bill that was passed during the year principally benefited manufacturers, multinational operations, agriculture businesses, and energy producers in the United States. However, small businesses, partnerships and real estate investors also receive some benefits.
Two years ago, Congress increased the maximum that small businesses were allowed to expense from $25,000 to $100,000. Under the law, that amount is reduced if total investment exceeds $400,000. That increase was a temporary measure designed to stimulate the economy, and it was intended to return to $25,000 in 2006. The law extends the higher amounts through 2007.
Congress also approved a 15-year straight-line recovery period for qualified leasehold improvements to nonresidential real estate property placed in service until 2006. This will result in a substantially quicker return than the 39-year period previously required.
Restaurants that occupy more than 50 percent of a building are also eligible for a 15-year period for properties placed in service before 2006. In that scenario, the property also is eligible for bonus first-year depreciation. Cost segregation of tangible personal property can further increase the size and speed of recovery of assets placed in service.
Kinder and gentler no more: What Congress gave, the Internal Revenue Service (IRS) later took away. As a result, in the late 1990s, the IRS was the subject of hearings on Capitol Hill in which many members of Congress took to the airwaves and testified to chastise the IRS for its mistreatment of the taxpayers.
Regardless of whether or not the abuse of the IRS by Congress was justified, it nevertheless did have an impact on the way the IRS worked. Audit rates began going down, and the IRS started working to improve its public image. However, the pendulum is now swinging back the other way. A number of former IRS commissioners have bemoaned the low audit rate and continuously express concern about what this has done to voluntary compliance.
President George W. Bush's budget contains substantially more funds for IRS enforcement and representatives of the IRS have indicated that it wants to "balance its traditional provision of service and outreach with an increased focus on enforcement."
The commissioner, in testimony before Congress, reminded them that "enforcement more than pays for itself." With the size of the deficit, look at Congress to consider funding the IRS a wise investment.
Expect the IRS to look at partnerships in particular to ensure that the arrangements have economic substance and are not tax shelters or abusive transactions. Congress assisted the IRS in this regard by providing substantially increased penalties for tax shelter abuses or for violating the tax shelter reporting rules.
One other position of the IRS drastically impacts all those properties that are owned through any kind of partnership structure. This is a major issue because the number of partnerships has greatly expanded throughout the past few years, particularly as a result of the popularity of the limited liability companies or partnerships (LLCs or LLPs).
As a result, the chief counsel issued a notice stating that the IRS will continue to enforce administrative levies and liens filed against a general partner based on assessments against partnerships. The Internal Revenue Service does not have to issue a separate assessment against the other partner.
Bush's administration is on record as being against higher taxes, having demonstrated that position throughout its first term, and reiterated it when Bush ran for a second term. However, the deficit continues to expand and revenue must be found. Those in the hospitality industry should look for a continued emphasis on enforcement and discussions on tax reform during the year.