Whether you’re a successful restaurant concept opening a new location, or a brand new restaurateur opening your very first storefront, a shiny new restaurant is always exciting! While you’re probably thinking a lot about your dollar return on investment and what profits will look like, you may not be so focused on how the startup costs will affect your after-opening financials. Let’s discuss what pre-opening or startup costs include, and how to account for pre-opening expenses.
Define Pre-Opening Expenses
Pre-opening expenses are, as you might imagine, costs that are incurred before the date that the restaurant begins selling food, made the website public, or simply attempted to market or sell food. Common pre-opening expenses include legal expenses to create or acquire a restaurant, costs to obtain or secure and prepare the space and storefront, amounts paid to obtain the kitchen and dining space equipment and furniture, hiring and training costs to staff the restaurant, fees paid to establish the necessary certifications to prepare and serve food to the public, and advertising or marketing expenses to announce the restaurant’s opening. You may hear a lot of different terms thrown around – pre-opening costs, pre-operating expenses, organization costs, startup costs – but they all mean the same thing: expenses incurred before the day you made your first sale.
Pre-Opening Expenses Treatment
We recommend keeping your books as close to GAAP as possible, and on an accrual basis, to get the most representative financial statements and KPIs. I mention this because your pre-opening expenses are treated a little differently on your books than for tax purposes. Here are the ways to account for pre-opening expenses:
Pre-Opening Expenses – On Your Books
Let’s start with how pre-operating costs are handled on your books. Financial accounting standards (Sec 720-15-15-2) lump all of these pre-opening expenses into one “startup cost” category because they’re all treated the same way: direct expense on the P&L, in the year incurred.
The exception is fixed assets. Fixed assets are their own breed of expense. If you purchase fixed assets such as capitalizable kitchen equipment or dining floor furniture, make significant capital or building/leasehold improvements, or spend a capitalizable investment in your restaurant’s POS system, those expenses are capitalized and depreciated according to the type and life of the asset.
Pre-Opening Expenses – On Your Tax Return
As you might expect, the tax code makes this approach to pre-opening costs a little more complicated. Unlike the expenses you incur after opening, your pre-opening costs accumulate on your balance sheet, except for the small amount you may be allowed to deduct in the first year. As non-operating costs, your pre-opening expenses will fall into three different categories with different tax treatments:
- Organizational costs – these expenses are incidental to creating the restaurant itself, such as legal fees for incorporating or writing up the partnership agreements.
- For c-corps and s-corps (Sec 248), you can deduct the lesser of your total organizational expenses or $5,000, on the first year’s tax return. If your organizational expenses exceed $50,000, your organizational cost deduction is reduced dollar-for-dollar by the amount that exceeds $50,000. You can deduct the rest over the next 180 months, starting when your restaurant opens.
- Example A: You incur $3,000 in state incorporation fees and fees paid to your lawyer for their hourly counsel on incorporation. On your first year’s tax return, you can deduct $3,000 as organizational costs.
- Example B: You incur $7,000 in state incorporation fees, fees paid to your attorney, and for an HR service to set up your payroll tax accounts. On your first year’s tax return, you can deduct $5,000 in organizational costs. On the following years’ tax returns, you can deduct $11.11 per month ($2,000/180 months).
- Example C: You incur $53,000 in state incorporation fees, registered agent fees, fees paid to your attorney for revisions to existing agreements to allow for your new restaurant concept, and for an HR service to set up your payroll tax accounts. On your first year’s tax return, you can deduct $2,000 as organizational costs ($5,000 limit – ($53,000 org costs-$50,000 threshold)). On the following years’ tax returns, you can deduct $283.33 (($53,000 org costs – $2,000 first-year deduction)/180 months) each month, which works out to about $3,400 per year for the next 15 years.
- For c-corps and s-corps (Sec 248), you can deduct the lesser of your total organizational expenses or $5,000, on the first year’s tax return. If your organizational expenses exceed $50,000, your organizational cost deduction is reduced dollar-for-dollar by the amount that exceeds $50,000. You can deduct the rest over the next 180 months, starting when your restaurant opens.
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- For partnerships, (Sec 1.709-1), generally no deduction is allowed unless the restaurant makes a special election on the first year tax return. Then, the organizational costs may be deducted and later amortized in the same manner as a corporation. Alternatively, the partnership may forgo the election and capitalize the organizational expenses. Capitalizing the assets puts them on the balance sheet rather than the P&L, which creates a different situation. We’ll talk about that in type 4, below.
- Start-up costs (Sec 195) – these are incurred after the restaurant has been formed (granted a legal name and EIN), but before the business has started. Examples include insurance expenses covering the time before the restaurant opens, expenses for licenses and permits, and any consulting or marketing fees to plan out the opening menu and advertise the opening. Unless a specific election is made, these expenses are not deductible. Once the election is made, a business may deduct up to $5,000 in the first year, with the same reduction for expenses over $50,000 described above.
- Intangible Costs (Sec 197) – Intangible costs are a little more nebulous than other expenses because they’re often abstract concepts like goodwill on buying out an existing restaurant or property, purchasing trade names, or copyrighting branding and design. There is no specific first-year deduction, but the cost of intangible assets is amortized over the 15-year period beginning with the month in which each intangible asset was acquired. This is the first of the pre-opening costs we have discussed which has NO $5,000 pre-opening deduction is the first year, and goes straight to amortization.
- Fixed Assets – fixed assets are subject to a special set of asset amortization and depreciation rules. Fixed assets include large and long-lived equipment, furniture, any vehicles to support the restaurant, and capital improvements to the restaurant space. Fixed assets obtained prior to your restaurant’s opening are not subject to any additional special rules; they just follow the same rules and elections as those fixed assets obtained or improved after opening with no first-year deduction. You may be able to use Sec 179 or bonus depreciation to reduce taxable income, but those are unrelated to pre-opening costs.
Pre-Opening Costs and Tax Planning
Tax planning should be revisited throughout the year – and for best results, even before operations have begun and your restaurant makes the first sale. These different types of pre-opening costs should be somewhere in your mind when setting up your restaurant, so that when reasonable, you can bifurcate as much as possible between each type of pre-opening cost (organizational, start-up, and certain fixed asset purchases) so that you can maximize your tax savings within each type of expense. For example, the cost of having a third party come in and help set up multiple pieces of kitchen equipment could arguably fall into two categories: start-up, or capitalized with the kitchen equipment fixed assets. If your start-up costs are NOT yet maxed out (you haven’t reached the $5,000 limit on pre-opening start-up costs deduction), you and your tax accountant may agree to classify that service a start-up cost. But if you have already maxed out the deduction, that cost is more beneficial as capitalized and captured under section 179 or bonus depreciation – which is a separate topic! The timing of when the expenses are incurred and when your restaurant opens its doors compared to the tax return year are also factors to consider in your discussion with our tax accountant.
Final Thoughts on Pre-Opening Costs
Although you may be tempted to make a strategy out of your pre-opening expenses based on how they will affect your tax return, the bottom line is that it’s best to incur only – and all of – the expenses necessary to successfully open your restaurant.
Still have questions, or want to know about specific pre-opening expense scenarios? Schedule a call with us!
