Two tax tips, often overlooked, may be worth the work
Everyone loves tax time, so certainly business owners know their deductions, allocations, recaptures and exclusions inside and out, right? Here are a couple of tax considerations that are easy to overlook.
Private equity planning: With the ongoing influx of private equity capital into the franchise sector, planning for that influx of cash and how it will affect the tax situation is critically important.
The first consideration is growing enough to beat the preferred return that private equity investors demand. “You have to grow that company on a faster rate so the math works and the existing investors get some money out of the deal,” said Jeff Tubaugh, a tax partner at BDO.
The preferred return complicates more than just growth, though. “The way the allocations work, because of that preferred return you could have a year where your company has a loss for tax purposes, maybe even for cash flow purposes because you’re opening restaurants. But you may still have to allocate taxable income to those owners because of that preferred return,” he said.
There are various tax tricks to get around the effects of the preferred return. That way the return doesn’t show up every year and turn a tax loss into taxable income, which no doubt will require smart negotiating and a thoughtful private equity investor, Commissary deduction: Real estate headaches and efficient growth are pushing the use of commissaries, and a little-known tax rule can mean some significant tax savings for those who do. Rules under section 199, the domestic production activities deduction (DPAD), mean anyone who manufactures something in a commissary can deduct some of that income.
“The idea behind this deduction is to carve out your production activities. You get an extra deduction for participating in those activities; it’s really designed to spur manufacturing,” said Lisa Haffer, tax office managing partner at BDO.
She said it only applies to income derived from a manufacturing commissary. “For someone who is making hamburger buns and shipping them to stores, all of a sudden you’ve produced the bun offsite so that the bun would qualify, the production for making the meal would not,” said Haffer.
She said deductions can have a significant impact for those who are willing to put in the work. “It can be up to 9 percent of the qualified income. But there are lot of different nuances and limitations that go into the deduction. Every situation is different,” said Haffer.
The accounting and right-sizing required across the operation can be worth it, since few accountants will scoff at a 9 percent deduction.