Rolling out a new app? Consider the tax issues first

Nikki Gold

Restaurants are finding that smartphone apps are becoming as necessary to their business as menus and napkins. Starbucks’ app offers a “Shake to Pay” feature to bring up the app instantly, the Domino’s Pizza app lets you track your order and Panera Bread’s app helps you count calories. Standard on virtually every app are such features as menus and GPS directions to the restaurant.

If your restaurant hasn’t hopped on the app wagon, it will. Some 58 percent of American adults have smartphones, according to the Pew Research Center. Among 20-somethings, the number is much higher. While we’re seeing a lot of innovation in restaurant apps now, the day will come when your app strategy will be noteworthy only if you don’t have one.

But hold on. Before you run to the nearest software developer, you’ll want to talk to your tax advisor about a couple of significant accounting ingredients in the app recipe.

Prepaid accounts must be recognized as deferred revenue

Starbucks allows you to load money onto your app and use it as a prepaid debit card. Chipotle Mexican Grill saves gift card credits. Some apps will link to PayPal accounts and allow for quick loading of funds. Increasingly, restaurant apps also function as an extension of the customer’s wallet.

Those preloaded but unspent funds may allow the restaurant to defer recognition of that revenue for up to one year if an advanced payment method is adopted. Preloaded apps, along with gift cards, also will cause restaurants that operate in multiple states to run into state revenue apportionment issues. A customer may load funds in Georgia, then use the card in the state next door. The issue becomes whether the revenue is sourced to Georgia or the state where it is redeemed. That means that behind the scenes of the fancy features that diners see on your app, you will need to determine the correct state(s) for sourcing gift card and advanced payment revenue. Each state has its own rules for tax treatment of these features, and you’ll have a tangled mess if you can’t start with the correct apportionment of these funds.

And it can get more complicated. A restaurant operating in multiple states that is taxed as a pass-through entity must consider issues that will impact partners, members and shareholders. For example, S Corporations or multimember LLCs will need to consider the impact of state nonresident taxes on its shareholders or owners. Restaurants in states such as Tennessee and Texas that assess entity-level taxes on the income of pass-through businesses must consider the impact of the accounting for this revenue.

Costs of developing an app get special tax treatment

With all of the competition to offer new features, the price of developing or licensing an app is going up. Fortunately, there may be tax strategies to deduct these expenses. Internally developed software can be treated as research and development for tax purposes and amortized over 60 months or deducted in the current accounting period. For licensed software—frequently a more affordable app option for a smaller restaurant—the cost can be deducted over the life of the license agreement. Software that is purchased can be amortized over 36 months. You may need other software and POS modifications to make your app work, and these also will have tax considerations.

Many apps interface with restaurants’ websites and this remains a gray area for tax purposes that hasn’t been definitively addressed by the U.S. Internal Revenue Service. One possibility is to deduct these costs as advertising expenses since that’s the basic purpose of a website, but the IRS has taken the position that such costs should be capitalized since the life of such expenses extends beyond one year. Unofficially, the IRS has said website expenses should be treated as software costs and therefore amortized over 36 months, an option that allows the most recovery of development costs. In certain cases, the website expenses might also come under research and development. This is an area where your tax adviser will make recommendations after considering all the variables of how your restaurant developed and uses its app.

The tax law on apps, like the apps themselves, is evolving as restaurants find new ways to integrate this technology into their businesses. If you’re thinking of introducing an app to your customers, consult a tax advisor who understands the menu of tax strategies. 

Nikki Gold is a tax senior at Bennett Thrasher in Atlanta. She handles real estate and international tax matters, with a specialty in restaurants.