Dealer Ops

Year End Tax Planning Ideas For Dealers And Their Dealership

In the last four years, the legislature has brought us two of the three largest tax cuts in United States history. Many of these changes have impacted dealers and we have noticed that some dealers’ CPAs are not taking full advantage of these changes. This article is intended to briefly highlight some of the items that dealers and their controllers should monitor in order to pay as little tax as possible.

Cost Segregation Studies

If you have recently purchased, constructed or expanded your facilities, then it may be possible for you to accelerate the tax savings associated with these costs. A real estate Cost Segregation Study helps accelerate income tax depreciation deductions and generates significant cash-flow savings for the dealership. Cost segregation is an IRS approved procedure for identifying and re-classifying capitalized amounts allocable to property and land improvements from building costs, which typically depreciate over 39 years. The tax savings for dealers have been outstanding.

What if you purchased, constructed or expanded your facilities prior to 2004? The IRS allows a “catch-up” of these previously-missed depreciation deductions which means that you can deduct, all in one year, the missed deductions from all previous years.

Advertising, Interest and Other Credits

The IRS is allowing dealers (as a matter of fact, many of these changes are now deemed automatic by the Service) to treat these payments as “trade discounts” for tax purposes. By treating these credits as a reduction to the cost of inventory instead of a reduction to the corresponding expense account dealers are significantly reducing their taxable income. One concern that dealers often raise is the impact on their salespeople and manager commissions. No worry here because the changes can be accounted for on the tax return only with no impact to your monthly financial statements or commissions.

Reduced Tax Rates on Dividends

For those dealerships that operate as C-corporations and pay income tax at the dealership level, the reduction to a 15 percent tax rate on dividend income received by the shareholder-dealer has resulted in some large tax savings. Furthermore, for those dealerships that have elected to be taxed as an S-corporation, an opportunity exists to finally “get at” the “trapped-in profits” of the dealership when it was a C-corporation.

In the past, S-corporation dealerships with accumulated earnings from C-corporation years had to pay significant taxes on distributions of these monies. Now, with the reduction in tax rates on dividends, we are advising many dealers to distribute these C-corporation profits to take advantage of the lower 15 percent tax rate. Please note that regardless of who wins of the November elections, it is likely that the tax rate on dividends will return to previous levels sometime in the future. Accordingly, you should consider taking advantage of these low rates now.

Depreciation Deductions

The 2003 Tax Act increased to 50 percent the first year depreciation deduction for assets purchased prior to December 31st of this year. This opportunity expires on January 1st and will not be extended. Some limitations apply to vehicles under 6000 GVW and to buildings (unless a cost segregation study is conducted). Also the advantageous 50 percent deduction is limited to purchases of new assets and is not available for used asset acquisitions.

In addition to the 50 percent deduction discussed above, an opportunity exists for dealers to make an election to expense, all in one year, the acquisition of new or used equipment purchases. This election (under Code Section 179) has been increased to $102,000 (with certain limitations).

Let’s look at the potential savings related to the acquisition of $150,000 of equipment:
Cost of the new equipment $150,000
Section 179 election (102,000)
50 percent bonus depreciation (24,000)
Normal depreciation (assume 20 percent) (4,800)

Remainder to depreciated in future years $ 19,200
As you can see, being able to write off roughly 88 percent of the cost of this asset in the current year would result in significant tax savings.
If you have not elected to utilize the LIFO method of accounting for your new vehicles, then you should consider it. You have made a significant investment in your vehicle inventory; why not let this investment reduce your income taxes? It is anticipated that new vehicle prices will have increased by 2 to 3 percent this year. When this inflation rate is applied to a large inventory the tax deferral can be staggering. Numerous dealers across the nation have saved millions of dollars in taxes over the years utilizing LIFO for their new vehicle inventories.
These are merely a few of the numerous tax savings ideas that can still be implemented before the end of the year. Other opportunities exist such as:
  • ? Accelerate expenses and defer income
  • ? Time your capital gains to take advantage of the 15 percent rate
  • Take advantage of the self-employed health deduction
  • Be aware of the Alternative Minimum Tax
  • Plan your gifting program wisely to take advantage of the exemptions
  • Shift income to children or others in lower tax brackets
  • Plan in order to avoid the “Kiddie Tax”
  • Take advantage of IRA’s for your children
  • Utilize IRAs, HSAs, 401(k) plans, etc.
  • Utilize non-qualified retirement and deferred compensation plans
  • Avoid personal debt since the interest is not deductible
  • Plan for educational expenses by using one of the many tax-advantaged plans
  • Utilize like-kind exchanges when possible to defer taxable gains on the sale of business or investment property
  • Examine the way your business is organized (C-corporation, S-corporation, LLC, etc.)
  • Begin your succession planning to avoid extremely high estate taxes
With federal income tax rates of approximately 40 percent your tax liability is a major expense that should be proactively managed by a professional with dealership taxation experience.
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