2005 CCH Whole Ball of Tax

Hungry to be an Entrepreneur?
Now May be the Time to Open a Restaurant, Says CCH

(RIVERWOODS, ILL., January 2005) – If you’re among the thousands of entrepreneurs each year looking to become your own boss, now may be your time – at least when it comes to favorable tax treatment, thanks to changes in the tax law enacted as part of the American Jobs Creation Act of 2004, according to CCH INCORPORATED (CCH), a leading provider of tax and accounting information, software and services (tax.cchgroup.com) and publisher of CCH Toolkit™ Tax Guide 2005. Among the Act’s provisions impacting small businesses are new start-up expense write-offs, more favorable expensing and depreciation deductions, liberalized S corporation membership rules, and new manufacturing deductions that apply to a broader class of manufacturers.

"Statistically speaking, it’s in the first few years that small businesses have the highest failure rates. Tax law changes can’t guarantee a business will survive the early years and go on to be a success, but they can offer some relief as owners start to build their businesses. Favorable tax laws can also lower barriers as they look for ways to expand their businesses," said Paul Gada, JD, LLM, CCH small business analyst and editor of CCH Toolkit Tax Guide 2005.

Gada adds that before pursuing entrepreneurial dreams, small business owners may want to first consult with their attorney and tax advisor.

Given that the new depreciation provisions provide special treatment for restaurants and manufacturers, CCH shows how the new tax laws may apply to a budding restaurant/food manufacturing business.

Sam and Christie decide to open a 100-seat Italian restaurant along with a small food manufacturing operation where they’ll make all-natural sauces for both the restaurant and packaged for retail and mail-order. This husband-and-wife team wants to build their enterprise as an S corporation and have their large, extended family involved as shareholders. Under the American Jobs Creation Act of 2004 (AJCA), the number of shareholders in an S corp expands from 75 to 100. It also treats all members of a family as one S corp shareholder. As a result, Christie and Sam are able to include all their children and their grandchildren as S corp shareholders, and count them all as one shareholder towards the new 100-member shareholder limit.

"There are a number of business formations open to small businesses and many factors that should go into the decision, but these new provisions are likely to boost the already fast growth of S corps, particularly when business owners are family members," said Gada.

Sam and Christie begin preparing their business in January of 2005 and open the doors of their restaurant and manufacturing site in the spring of 2005. They incur $7,000 in start-up costs before opening. They decide they will expense the maximum of $5,000 in 2005 and amortize the $2,000 over 15 years.

Historically, start-up expenses for a new business had to be amortized over 60 months, starting in the first month the business actually began to run. Under the AJCA, new businesses now can elect to deduct up to $5,000 in start-up expenses during the first year, for those costs incurred after October 22, 2004. However, the trade-off is that they must use a 15-year amortization period in deducting any additional start-up expenses in excess of $5,000.

Start-up costs include the costs for market and product research, site selection, and fees for attorneys and other consultants needed in starting the business. Expenditures such as real estate taxes or interest charges do not qualify for start-up expensing but can be deducted when incurred. Incorporation costs also are not eligible for start-up expensing, but can be deducted over the applicable amortization period. Likewise, property that can be depreciated, such as equipment, does not qualify.

"The accelerated expensing is really designed to provide relief to very small businesses with relatively low start-up expenses," said Gada. "For a larger organization that may incur expenses of more than a few thousand dollars, the idea of immediately writing off $5,000 isn’t all that attractive if they must use a 15-year, versus the traditional 60-month, schedule to write off many more thousands of dollars."

Sam and Christie select a site in their city’s downtown area. The building had formally housed a bakery and card shop for more than a decade. Overall, their restaurant will take up about two-thirds of the building, with the food manufacturing business occupying the rest of the site. Their remodeling in early 2005 included new floors and fixtures, expansion of the kitchen area, development of a special manufacturing area for the mail-order and retail sauces and installation of new industrial grade appliances. Rather than the traditional 39-year depreciation period, they will be able to take advantage of the new 15-year recovery period. Additionally, both expenses from the restaurant and manufacturing sides will be eligible for expensing under the extended small business expensing rules.

Under the AJCA , businesses can now use a 15-year, straight-line depreciation recovery period for qualified leasehold improvements to nonresidential real property placed in service after October 22, 2004 but before January 1, 2006. Previously, a "qualified" leasehold improvement had to be depreciated using straight-line depreciation over a 39-year period. Qualified leasehold improvements apply only to the interior of a building and must be placed into service more than three years after the building was first placed into service.

Similarly, the new law also provides a 15-year recovery period for qualified restaurant property placed in service after October 22, 2004 and before January 1, 2006.

Although there is some overlap between the two under certain circumstances, the provision for qualified restaurant property is much broader in that it is not limited to leasehold improvements or by other restrictions that apply to qualified leasehold improvement property.

Additionally, the increased small business expensing perk, set to expire at the end of 2005, has been extended through 2007. This benefit allows a small business to expense up to $105,000 of new equipment in 2005 for investments up to $420,000. The original first year expensing limit of $25,000 per year was expanded to $100,000 for tax year 2003. The accelerated expensing option now remains in effect through 2007 and is indexed for inflation.

"The extension of these rules means small business owners have more time to realize tax-savings. They can take a measured approach to growth over several years and still be eligible for the favorable tax treatment without potentially over-extending themselves," said Gada.

While the restaurant portion of Sam’s and Christie’s business is able to capitalize on special depreciation rules, the sauce manufacturing side of the operation is able to take advantage of reduced corporate income tax rates.

This new deduction for manufacturers reduces the corporate income tax rate for domestic manufacturing 3 percentage points for 2005 and 2006, rising to 6 percent for 2007 through 2009 before reaching 9 percent in 2010.

In addition, manufacturers are broadly defined to include construction activities; engineering and architectural services; energy production; qualified film or videotape production; and certain farming operations involved with the processing of agricultural products.

"A manufacturing operation that supplies products on site for consumption – for example, in a restaurant – as well as packages and distributes for retail sale, can only take the deduction for the manufacturing process for the packaged side," said Gada. "So, these dual types of organizations need to track separately all of the income and expenses for both operations."

CCH Toolkit Tax Guide 2005 is available in bookstores nationwide, by phone at 800-248-3248 or online on the CCH Business Owner’s Toolkit site (www.toolkit.cch.com). The online site also offers additional information and software tools to help you start, run and grow your home office or small business, including instant access to federal and state information, calculators and forms.

CCH INCORPORATED (tax.cchgroup.com), based in Riverwoods, Ill., is a leading provider of tax and accounting information, software and services. It has served tax, accounting and business professionals and their clients since 1913. CCH is a Wolters Kluwer company (www.wolterskluwer.com).

Wolters Kluwer is a leading multinational publisher and information services company. The company’s core markets are spread across the health, tax, accounting, corporate, financial services, legal and regulatory, and education sectors. Wolters Kluwer has annual revenues (2003) of €3.4 billion, employs approximately 18,750 people worldwide and maintains operations across Europe, North America and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. Its depositary receipts of shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices.

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nb-05-05