Frequently Asked Accounting Questions
During the course of a year, accountants are asked many different questions. Some of the more frequent questions are: What should I pay myself for salary? What should I pay myself for rent, and what should the lease term be? Should I consider starting a buy here pay here (BHPH) operation if I am a new car dealer? If I already have a BHPH operation, should I start a related finance company (RFC)? Why am I losing money in certain departments? Should I pay out dividends to beat the probable increase in tax rates? I will attempt to answer some of these questions this month.
What should I pay myself for salary? If you file your company tax returns as a C or S corporation, you need to show some officer wages paid to an active officer during the year. It doesn’t necessarily have to be a stockholder, as all stockholders are not officers of the corporation. If you file as a sole proprietorship, partnership or an LLC, you should not pay the owners/partners/members a wage. The partners/members should take out distributions and pay estimated income taxes quarterly.
An S corporation must pay reasonable compensation (subject to employment taxes) to shareholder employees in return for the services the employees provide to the corporation, before non-wage distributions may be made to shareholder employees.
The amount of reasonable compensation varies based on what time is spent and the value of those services, as if you had to hire someone to perform those duties. This issue has been identified as an area of non-compliance and will receive greater scrutiny in the foreseeable future.
What should I pay myself for rent and what should the lease term be? The amount of rent paid should be equal to a reasonable rate of return on the appraised value of the real estate. Commonly-used rates vary from eight to 10 percent under a triple net lease. For example, if the property is valued at $1 million, using an eight percent return would generate rent of $80,000 per year or $6,667 per month. This may be very different from the actual mortgage payment because you may be paying off the mortgage at an accelerated rate.
The lease term normally varies from an annual to a multi-year term. The lease term may be whatever length you want, as you may amend it if necessary in the future. Some dealers, due to the hard economic times we are currently in, have lowered or suspended rent to themselves if they were capable of still paying the mortgage (if any) from other sources. You can insert a clause in the lease where you are entitled to pay yourself the unpaid rent from this time period when the company leasing the real estate is financially able to do so.
Should I consider starting a buy here pay here (BHPH) operation if I am a new car dealer? If you are a new car dealer, whether struggling or not, and you have adequate capital or the ability to obtain enough financing, you may want to research whether a BHPH operation can be utilized to expand your sales to the subprime or lower markets. Since the number of subprime finance sources has been greatly reduced, there is an opportunity to sell some of these customers, increase your gross profits and bottom line, and have a payment stream coming in even if you are not selling new cars. Based on your proposed unit sales, average cost and sales price of the vehicle, there will be some negative cash flow until your portfolio grows to a certain size and levels off. This is why you need to have an adequate supply of capital or financing before thinking about a BHPH operation.
If I already have a BHPH operation, should I start a related finance company (RFC)? Based on your state sales tax laws, your net income or loss from the dealership, cash flow, adequate capitalization and/or financing available, you may want to consider an RFC to enable your dealership to sell the notes at fair market value to the RFC. This defers some of the gross profit until you actually collect it on a cash basis. Most dealerships should be using the accrual basis of accounting for federal income tax, which makes the dealership report all the gross profit at the time of the sale. Even if your dealership doesn’t have income in the current year, but had income in the prior years, generating a net operating loss which can be carried back to prior years can generate federal and state income tax refunds.
Why am I losing money in certain departments? You should review your department bottom lines and compare them to prior periods/years and industry averages to determine what has changed. Losing money can be caused by lower-than-normal sales, lower gross profits and/or higher expenses. Your expenses may appear to be high based on sales, but they may be the lowest you can get them to be and still have a department operational. The only fix may be to increase the sales or absorb the losses until sales can improve to generate a profit. Another cause may be an inaccurate allocation of expenses to the department(s) in question. Review the actual general ledger account detail line items for each expense in every department to determine if this is causing the problem. Compare your gross profit percentages with industry averages to determine if you are charging enough to cover the cost of goods and expenses you are paying.
Should I pay out dividends to myself and pay the income taxes now to beat the probable increase in tax rates? This is a hard question to answer without knowing all the pertinent facts of your situation. Undoubtedly there is severe pressure on the federal and state governments to increase the tax rates to generate revenue. Most state governments are broke and are running large deficits, as is the federal government. The money has to come from somewhere. My crystal ball has not been working well lately, so it is a guess right now on everyone’s part as to what tax rates will do in future years. I don’t believe they will be reduced in the near future. A projection should be completed based on your personal situation and the tax brackets you are currently paying at and expect to pay in the near future to determine if paying the taxes now makes sense based on the time value of money and the available funds to pay the tax now rather than later. As the government sometimes backdates the period when tax law changes become effective it can definitely be a toss-up on whether to complete a transaction now rather than later.
Summary. On all the questions above you should consult with your tax advisor and work through the various scenarios or complete projections on a probable outcome. Without proper planning, the results can cost you money and profits. If you have the appropriate knowledge, you can trigger the correct scenario timely to obtain the best results.
Vol. 7, Issue 2