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Hotel Industry Overview - August 2007 - Significant Law and Important Issues

LMSB-04-0807-054

"This document is not an official pronouncement of the law or the position of the Service and cannot be used, or cited, or relied upon as such."

Significant Law and Important Issues

A. Coordinated Issues

 

Issue

Brief Summary of Issue

 

There are currently no coordinated issues

B. Emerging or Other Significant Issues

 

Issue

Brief Summary of Issue

Depreciable Life of a Hotel’s Small wares Asset Account and Treatment of Replacements

When a hotel opens a location, they will purchase thousands of dollars worth of smallwares (towels, sheets, blankets, glassware, china, silverware, linen, etc.).  A potential issue had been identified relating to the recovery period of these assets and how to treat the replacement costs of these items. 

Losses Incurred When a Hotel is Closed

 

 

 

 

Is a taxpayer entitled to deduct the difference between the adjusted basis of the property and its appraised value when a location is closed but not disposed of?    Some taxpayers are taking the position that when the building is owned, they are entitled to a loss in the form of bonus depreciation equal to the difference between the adjusted basis and the appraised value of the building, when a decision is made to close an unprofitable location.  The current IRS position is that a loss on the Section 1250 property is not allowed until an actual disposition (sale or abandonment) has occurred.  The mere closing of the property is not an actual disposition. 

Deferral of Gift Card Sales

Are taxpayers properly following the rules for deferral under Treas. Reg. § 1.451-5?  Is a CAM required?  Was an information schedule attached to the tax return?  Is income from unredeemed gift cards brought into income after 2 years?  Was a separate company set up to manage the program?   Can the taxpayer track the outstanding liability?

Guest Loyalty/ Reward Programs

1.  What is the proper character of a reward point?  Is a reward point a “rebate or refund” as provided in Treas. Reg. § 1.461-4(g)(3) or a “trading stamp or premium coupon” as provided in Treas. Reg. § 1.451-4(a)?  The characterization will affect the timing of expense recognition.  Whereas a trading stamp or premium coupon may reduce gross income at the time of the corresponding sale, a rebate or refund will not reduce gross income until payment is made to the person to which the liability is owed.  Furthermore, when is the liability fixed: at the time a customer is issued or redeems a reward certificate? 

2. What is the cost of a reward point?  How was the estimated average cost of redeeming each point computed?  Did the retailer include only the costs to acquire the merchandise, cash, or other property required to redeem the points, or did the taxpayer include other costs such as advertising catalogs, transporting and storing merchandise, operating redemption centers, etc.?

3. What methodology was used to estimate future redemptions?  Does the methodology result in a reasonably accurate estimate of the points outstanding at the end of the taxable year that will ultimately be presented for redemption? Although an expense may be deductible before it is due and payable, the liability must be firmly established.  Is the liability fixed prior to the customer’s accumulation of the minimum number of points needed to earn a reward certificate?  Does the methodology take into consideration any expiration of previously earned points?

4. Does the recurring item exception provided under Treas. Reg. § 1.461-5 apply if the reward certificate is determined to constitute a rebate?

Cost Segregation Studies

Many hotels are the subject of cost segregation studies.  An Audit Technique Guide (ATG) for the preparation and examination of cost segregation studies was initially issued in April 2004 and was most recently updated in January 2006.  The primary goal is to provide examiners with an understanding of why cost segregation studies are performed by taxpayers, how such studies are prepared, and what to look for in the review and examination of these studies.  This guide will also assist taxpayers and practitioners in understanding some of the items the Service will consider to support property allocations based on these studies.  Included in the ATG is industry specific guidance for land-based casinos, restaurants, and retail establishments which were previously issued as Industry Director Directives.   It should be noted that this ATG is not an official Service pronouncement and may not be cited as authority.

Contributions of Hotel Beds

Some of the problems encountered during examinations are as follows:

  • Contribution made to an organization that is not a qualifying organization.
  • Fair market value (this is the area where most disputes between the taxpayer and the Service occur).

WOTC/WTW Claims

Rev. Rul. 2003-112 provided guidance on whether an individual meets the family membership requirements permitting certification for the WOTC and WTW credits.  Some states may have applied a narrower definition in issuing certificates.  Many taxpayers are currently filing claims using the revenue ruling as justification.  These claims SHOULD NOT be allowed without proper substantiation.   The current Service position is that additional credit should only be allowed when the taxpayer has documented certification from the state agencies.

Tax Abatements

At issue is the proper tax treatment on State & Local Economic Development Subsidies.  This might include inducements & Enticements to persuade companies to relocate or maintain their investment in that particular area.  Some taxpayers are taking the position that they are entitled to a deduction for a tax abatement.  Further, they account for the abatement as income under IRC § 118 and then reduce basis in long life assets or land under IRC § 362.  This accounting treatment is an emerging issue in all industries.

FICA Tax Tip Credit

  • Should a taxpayer be allowed a credit under section 45B on Service Charges allocated to servers? 
  • Should a taxpayer be allowed a credit under section 45B on both directly tipped and indirectly tipped employees? 
  • Should a taxpayer be allowed a credit under section 45B for the difference paid for minimum wages for the first 90 days for employees under age 21? 

These are some of the issues that hotels with restaurants will face.  When a service fee is charged by the restaurant, typically on large parties, banquets, or catering, these amounts are not eligible for the FICA tax tip credit under IRC § 45B.

Franchising Fees

Some hotels are requiring nonrefundable franchisee fees upfront, perhaps several years before the franchisees actually get their hotels.   When examining franchisers, you should inquire as to their policy for reporting these advance fees.  Some are properly including them in income and some are not.

Upfront Payments

In some situations vendors will enter into long term agreements with hotels.  These contracts typically call for a large up-front payment from the vendor to the hotel.    In return the recipient agrees to purchase product for a given time period or the recipient agrees to purchase a stated amount of product in the future with no time period mentioned.  The contracts will usually stipulate that the vendor will either be the exclusive supplier of the product or that the vendor is the primary vendor and will receive preferential placement of the product for an extended period of time.  Typically in hotels you may see this from the soft drink provider.

Lobbying Deductions

The principal issue is whether costs incurred to influence legislation that impacts a taxpayer's business or industry are deductible as ordinary and necessary business expenses under IRC § 162(a).

The general audit approach is to determine if the activity is covered by IRC § 162(e).  If yes, no deduction is permitted.  If no, the activity is deductible to the extent it meets the requirements of IRC § 162(a).

Generally, IRC § 162(e)(1) provides for no deduction of amounts paid or incurred in connection with any of the following four activities:

  1. "Influencing legislation" (i.e., direct lobbying of the legislature);
  2. Participating in a political campaign of a candidate for public office;
  3. Attempting to influence the public regarding elections, legislative matters, or referendums (i.e. grassroots lobbying); or;
  4. Communicating with "covered executive branch officials."

Treas. Reg. § 1.162-29 defines "influencing legislation" as any attempt to influence legislation through a lobbying communication and all ancillary activities engaged in for the purpose of making or supporting a lobbying communication.

One area that is often overlooked is dues paid to trade associations. 

The following website allows you to search by company name and see who is registered to lobby on the company's behalf and the amount of lobbying-related income from the company/client. http://sopr.senate.gov.

C.  Recent or Pending Legislation

 

Effective Date

Title

Summary and Impact of Legislation

N/A

 

 

D.  Specific Industry Related Tax Law

 

Effective Date

Code Section

Summary and Impact of Law

Temporary Provision that is Usually Renewed Periodically

Sections 51 and 51A

Employers who hire certain targeted low-income groups may be eligible for an annual tax credit of up to $2,400 for each qualifying employee who works at least 400 hours during the tax year. Additionally, a maximum credit of $1,200 may be available for each qualifying summer youth employee.    These credits are known as the Work Opportunity Tax Credit and Welfare to Work Tax Credit.

Current

Section 170(e)(3)

Allows C Corporations an enhanced deduction for qualified contributions of inventory to qualified organizations.

Current

Section 190

This annual deduction of up to $15,000 is available to businesses of any size for the costs of removing barriers for people with disabilities, including the following: providing accessible parking spaces, ramps, and curb cuts; providing wheelchair-accessible telephones, water fountains, and restrooms; making walkways at least 48 inches wide; and making entrances accessible.

 

July 25, 1991

Section 197

Generally, section 197 intangibles include designs (package designs).  However, if the design is self-created, the asset is a Section 197 intangible, but not an amortizable Section 197 intangible.  Therefore, the 15-year recovery period does not apply.  The aforementioned Coordinated Issue Paper discusses the methods available for cost recovery.

E. Important Revenue Rulings or Revenue Procedures

 

Effective Date

Title and Number

Summary and Impact of Ruling and Procedure

 

 

 

 

 

 

Retroactive

Revenue Ruling 98-39

Ruling discusses year end accruals relating to outstanding liability a manufacturer has under cooperative advertising arrangements with retailers, specifically the ruling states that the fact of liability is established when a retailer conducts qualified advertising vs. when a claim for reimbursement is received from the retailer.  Revenue Ruling 98-39 was the desirable method of announcing that the Service has changed its position on the issues addressed in TAM’s, 9320001, 9343006, 9204003 and 9416004.

2002

Revenue Procedure 2002-12

On January 7, 2002, the Service issued guidance (Rev. Proc. 2002-12) on a safe harbor method of accounting for the cost of smallwares for restaurants.   The IRS will now allow for the cost of certain restaurant smallwares to be current year deductible expenses.

F.  Important Court Cases

 

Date Opinion Issued

Name of Court Case and Citation

Summary of Importance of Court Case

1990

Jefferson Pilot Corp. v. Comm.  98 T.C. 435 (1992), affd. 995 F2d 530 (4th Cir. 1993)

The court determined that a license is a franchise as defined in IRC Section 1253(b)(1).  The Courts looked to the legislative history of IRC Section 1253 and found that it does not limit the application of IRC Section 1253 to private commercial franchises.  This has resulted in taxpayers filing Forms 3115 to change their method of accounting for the cost of liquor licenses.  Previously the Service’s position was that a liquor license had an indeterminate life and therefore costs were not recoverable through depreciation or amortization.  As a result of this decision, taxpayers can amortize the cost of their liquor license. See also

Tele-Communications Inc. (TCI) v. Comm. 95 T.C. 495 (1990)

Affd. 12F 3d 1005 (10th Cir. 1993)

1999

H Group Holding, Inc. v. Commissioner, T.C. Memo 1999-334

The court modified the IRS’s holding that petitioner subsidiary for mark licensing outside the United States should be increased by 1.5 percent of the gross revenues of those hotels whose management fees were remitted to two subsidiaries in Hong Kong and Singapore that were also hotel management companies, taking into consideration adjustments.

2001

WestPac Pacific Hotels, et. Al. V. Commissioner, T.C. Memo 2001-175

The Tax Court has held that a partnership that distributed goods to related grocery chains wasn’t entitled to defer recognition of upfront cash payments as income from various manufacturers beyond the year of receipt.

G.  Technical Advice Memorandums - Field Service Advices

PLRs AND TAMs ARE ADDRESSED ONLY TO THE TAXPAYERS WHOREQUESTED THEM.  FSAs ARE NOT BINDING ON EXAMINATION ORAPPEALS, NOR ARE THEY FINAL DETERMINATIONS.  FURTHERMORE,SECTION 6110(k)(3) PROVIDES THAT PLRs, TAMs, AND FSAs MAY NOTBE USED OR CITED AS PRECEDENT.

 

 

Number

Description

FSA

200203009

Recovery Period for various components of a hotel/casino

 

Chapters 7 & 8 | Table of Contents | Chapters 10 & 11 

Page Last Reviewed or Updated: 27-Nov-2013