Question

In case you have never viewed Kitchen Nightmares or Bar Rescue, here’s the drill: a beleaguered owner of a 1970s roach-infested bar/grille/restaurant featuring freezer-burned food sautéed with bacteria “cooked” in a non-functioning microwave reaches out to Gordon Ramsay or Jon Taffer for help. Apparently, he or she cannot imagine why the business is failing. Yet, despite the owner’s insistence that the food is awesome, the patrons have disappeared and mountains of unpaid bills (including delinquent—most likely payroll taxes) are piled high on the owner’s desk in a makeshift fire hazard cluttered office. Although Jimmy Buffett might say “there is a woman to blame,” the owners blame the economy or a disrespectful staff, or both, (never the food or themselves) for their dire economic situation. Go figure.

In Kitchen Nightmares, for example, after hearing a barrage of excuses and finger pointing, Gordon Ramsay scratches his head and says “Right.” Then, after sampling each “dish” on a menu with more pages than the Internal Revenue Code and spitting it out in disgust, he compares the food unfavorably to inedible scraps he would not even feed to a mouse or other rodent. In response to Ramsay’s profanity-laced, bleeped-out assertions that the owner is delusional and in denial for not acknowledging indisputable evidence that the food is lousy, the owner stubbornly insists that it is the best cuisine in town loved by loyal diners (of which there are none).

Predictably, after 50 television minutes of air time, the poor soul owner suddenly realizes that being reamed out, degraded, and exposed as a selfish and disrespectful owner who has “given up” or “doesn’t care” on national television is actually constructive criticism rather than the very personal character assassination it had originally seemed to be. After finally acknowledging that he or she is the blame, there is an emotional epiphany followed by happy talk about looking forward optimistically into the future.

Finally, waiving a magic wand that would be the envy of Cinderella’s fairy godmother, miraculously and literally overnight, Ramsay’s crew of carpenters, designers and electricians the size of a small (or not so small) army transforms the roach infested dump that should have been condemned into a five-star fine dining establishment. The transformation often includes the installation of state-of-the-art kitchen equipment, a professional cleaning, a new eye-catching sign, a complete inside and outside renovation (including new floors, art work, high definition televisions, lighting and other expensive décor), and maybe an executive chef to run the kitchen for six months.

In the aftermath of the smiles and hugs followed by the closing credits, there is an inconvenient tax issue. Cleary any owner on the verge of financial ruin would gladly accept Ramsay’s or Taffer’s offer to transform the failing restaurant or bar from a dump to palace.

Wow! Check please. In other words, who pays the exorbitant cost of the transformation? Obviously, it is the network, certainly not the hopelessly-in-debt owner, who pays.

Submit a thoughtful analysis of income tax issues you glean from the fact pattern. There may be tax issues with respect to the network as well as the downtrodden owner. In order to get full credit, you must fully analyze each issue and explain your conclusion. For example, if you determine whether something is taxable or non-taxable, simply stating that is not sufficient. Instead, you must explain the rationale for your conclusion.

Answer 1

The provisions of Internal Revenue Code do not permit exchanging humiliation for life changing improvements is to be tax-free exchange.

However the Code does not operate in a vacuum and considering the fact that the owner is in under heavy debt, the possible relief options are as follows there are several possible avenues for relief:

• Prior year(s) Net operating Losses (NOL) can be carried forward to the tax year of transformation and can be used to set off with the income. With such huge pile of losses, the accumulated losses may even wipe off the current income as well as the tax liability
• The other scenario can be that in absence of accumulated NOL, current year losses may be significantly negative to offset all or most of the income earned due to transformation.

Another thing to keep in mind prior year(s) NOLs or current year’s losses do not affect onerous payroll tax liability. Payroll tax liability cannot be adjusted.