By Steven Murphy, Todd McMullen, Rusty Lane

This article was originally published on the GACS Today – Summer 2018, a magazine for the Georgia Association of Convenience Stores.

With the passing of Tax Reform at the end of 2017, it is time to begin looking at a few of the potential opportunities and challenges that lie ahead for the Convenience Store Industry.

Top 3 Opportunities

The Tax Reform and Jobs Act of 2017 lowered corporate and individual tax rates, enacted a 20% deduction on taxable income from pass-through entities, and offers 100% bonus depreciation on many new and used purchases made after September 27, 2017.

1. Lower tax rates
Beginning January 1, 2018, C-Corporations are now taxed at a flat 21% income tax rate.  This is a 14% reduction from the previous highest rate of 35%.  The reduced rate has resulted in increased earnings for most C-Corporations as they adjust the deferred taxes on their financial statements for the new rate.  The change was made permanent and does not have an expiration date.  However, we all know that nothing in Congress is ever permanent.  Also, keep in mind that dividends from the C-Corporation are still taxed at 20% and results in double taxation.  Therefore, a full analysis needs to be done before anyone rushes to change their tax entity status from a pass-through entity to a C-Corporation.

In addition, there was tax relief for companies that are structured as pass-through entities for tax purposes.  Since income from pass-through entities is taxed at the individual rate, the lowering of these rates could result in tax savings.  The highest individual tax rate was lowered from 39.6% to 37%.  In addition, the highest rate begins with taxable income for married filing joint above $600,000 ($500,000 single), which is an increase from the previous high of $470,700 ($418,400 single).   See table below highlighting the old vs. the new tax brackets. There are other changes made at the individual level which are not discussed in this article, and those implications could both increase and decrease the amount of taxes due.

2. Pass-through entity deduction
Pass-through entities are also now eligible for a 20% deduction on the owner’s individual returns.  The 20% deduction is based on the lower of “Qualified Business Income” or taxable income.  There are limitations on the 20% deduction based on the amount of wages paid and property owned so you will want to consult with your tax advisor to make sure you are able to maximize this benefit.  The 20% deduction results in your pass-through income being taxed at a lower 29%-32% tax rate.  While this is higher than the C-Corporation rate, pass-through entities can usually avoid the additional 20% tax levied on distributions.

3. Bonus depreciation expansion
Another provision that has a big impact on the C-store Industry is the increased percentage and flexibility of bonus depreciation.  Prior to the new tax bill, you could immediately expense 50% of your new asset purchases under the bonus depreciation provision.  The new bill now allows bonus depreciation to include used assets and increases the deduction to 100%.  The new law applies to assets purchased after September 27, 2017, with a MACRS life of less than 20 years. The ability to take an immediate write-off on most capital equipment should provide a large benefit for those upgrading or adding stores.  The 100% amount is in place until the end of 2022 before it begins to be phased out.

Top 3 Challenges

There are also several revenue raisers in this tax bill, and we will cover some of the law changes that impact the industry, such as further limitations on the deductibility of interest expense and entertainment.  There were also limitations put in place for net operating losses and pass-through losses.

1. Limits on interest deductions
With the new tax bill, the first item to note is that there is a potential limitation to the deductibility of interest expense. The new law limits interest expense to the extent it exceeds 30% of adjusted taxable income.  Adjusted taxable income is taxable income before interest, taxes, depreciation, and amortization.  After four years, the rule is further capped by eliminating the addback for depreciation and amortization.  This change should be analyzed as you decide whether to fund future capital expenditures through debt financing or cash flow.

2. Further limitations on entertainment expenses
The second item that has been limited is entertainment expenses.  The previous law limited entertainment expenses to 50% deductibility.  The new law now disallows 100% of entertainment expenses.  There are some exceptions to this limitation such as holiday parties, summer outings, and attending trade conventions.

3. Limitations on net operating losses
The last item limited by the tax law change relates to losses from pass-through entities and Net Operating Losses.  Beginning in 2018, the amount of net business losses that pass-through to an individual is capped at $500,000.  The remaining amount is carried forward to future years and subject to the new Net Operating Loss rules.  The Net Operating Loss rules have been changed to remove the 2-year carryback and are limited to 80% of taxable income (it was 100% prior to 2018).

As you can see, there are several favorable and unfavorable changes to the tax law.   Also, keep in mind that we have only covered a few of the many changes that were made in this tax bill.  It is important that you take the time to meet with your advisors to better understand how the changes impact your business and how to maximize your tax savings while avoiding the potential pitfalls.

About the authors – Steven Murphy, Todd McMullen, and Rusty Lane lead the C-Store Industry Practice at Moore Colson CPAs and Advisors. Moore Colson is a proud long-time member of GACS.