You can’t avoid Uncle Sam completely unless you die or lie. Most people would prefer to avoid the casket and jail, but still want to reduce their tax liability. Here are 11 ways to legally reduce the amount of money Uncle Sam takes from your pocket at year end.
1. Write Offs and Accruals
Significant tax savings can result from writing off uncollectible accounts receivable and proper accrual of all expenses and liabilities at year end. To accomplish this, dealerships should maintain clean accounting records each and every month. Your accounting staff should be charged with maintaining all dealership accounts through monthly reconciliation and review. This is necessary to correctly reflect accurate financial statements and information throughout the year, while avoiding excessive accounting adjustments at year end.
2. Obsolescence
Check all parts inventory for any obsolescent parts. Return all obsolete parts to the vendor for credit before the end of the year. Dispose of and write off any remaining outdated parts inventory that can not be returned for credit.
3. Prepaid Insurance
If there is less than 12 months remaining on your current policy at the end of the tax year, the dealership can expense the entire policy in the current year.
4. Hybrid Tax Credits
There are tax credits available to consumers for the purchase of hybrid vehicles, but not all customers can utilize those credits. For example, not-for-profit organizations or charities that purchase a hybrid are not entitled to the hybrid tax credit because of their tax status. In those situations, the dealership may claim the tax credit instead as long as the dealership notified the organization at the point of sale that the dealership would claim the credit.
5. Energy Tax Benefits
In 2005, an energy tax bill was passed which allows a tax deduction for installing items that significantly reduce energy cost. Items such as insulation, new windows or energy control systems qualify, and the deduction is for a portion of the upfront cost of installation.
6. Federal Excise Tax Credit
The courts have found that you really were being charged too much for federal excise taxes. Technically, they found that charges for federal excise taxes on your telephone bill were unconstitutional, therefore the IRS has had to address the finding. As of November 2006, the IRS will allow businesses a tax credit for the amount paid for federal excise taxes on your telephone bills after Feb. 28, 2003, and before Aug. 1, 2006. Because this ruling is so new, the IRS is still finalizing the tax guidance on this issue, so make sure you ask your CPA for the final guidelines. Have your accounts payable clerk pull these records for you so you know how much you are entitled to.
7. Interest or Floor Plan Assistance
Substantial deductions are available by changing the accounting treatment of interest assistance plans. Most manufacturers have a program under which they pay the dealer a certain amount labeled “interest” or “floor plan assistance” for stocking a purchased vehicle. In reality, they are a cost reduction of the vehicle. Dealerships generally apply these payments to floor plan interest expense when received and consequently recognize them as income. By changing the accounting treatment to reduce the vehicle inventory cost rather than recognizing income, a nice tax deferral is created. This accounting change requires a filing with the IRS.
8. Advertising Charges
Vehicle advertising charges also offer big deductions. Dealerships are routinely charged an advertising fee on all new vehicle invoices for advertising associations, co-ops or other programs. These charges represent advertising expenses of the dealership and are not inventory cost under general tax principles. Most dealerships include this advertising charge in inventory, and consequently, it doesn’t get deducted until the vehicle is sold. By changing the accounting treatment to expense these charges rather than maintaining them in inventory, a significant deduction will result. This accounting change requires a filing with the IRS.
9. Other Inventory Charges
For a variety of business reasons, dealerships charge “packs” or similar items to inventory. Depending on how these charges are recorded, a dealership may be creating unnecessary income in an earlier tax period than necessary. The same concept applies to repair orders. Profits from internal repair orders to inventory also create unnecessary taxable income. By changing the accounting treatment of these items, dealers can reduce their taxes further. However, this change in accounting may require a filing with IRS.
10. Depreciation
For some dealerships contemplating asset purchases, it would be wise to review with your CPA the advantages available under Section 179. Section 179 allows a business, which meets specific guidelines with qualifying assets, to speed up the depreciation process considerably. For 2006, up to $108,000 in asset purchases can be depreciated in full in the year of purchase if the total of all assets purchased during the year does not exceed $430,000. If more than $430,000 was purchased, there is a dollar-for-dollar reduction in the amount eligible. Qualifying assets are broad and generally consist of anything except land and buildings. To capitalize on this deduction,purchase something your dealership needs this year, or if you are already over the limits, defer your purchase until next year.
There is another section of code regarding depreciation that is often overlooked called Class 57.0 assets. The condensed version of this code states that some furniture or equipment which would normally fall under one set of depreciation guidelines may be classified under a shorter depreciation cycle based on the use of the asset. For example, a desk in the accounting office is a 7-year asset, while the same desk in the showroom used by the sales department qualifies as a 5-year depreciable asset. All assets should be checked against Publication 946 which explains how to compute depreciation deductions. The IRS provides a "Table of Class Lives and Recovery Periods" which provides guidance for classifying an asset according to the business activity in which the asset is primarily used.
11. Cost Segregation
Cost segregation can be applied to new construction, the purchase of an existing dealership property or even to property that has been owned for some years.
Typically commercial buildings like auto dealerships are depreciated over a long period of time causing the tax benefits to be stretched over 39 years. A cost segregation study identifies specific building costs that qualify as personal property under tax law and consequently qualify for shorter lives for depreciation deduction such as five, seven or 15 years.
For example, assume a $5 million dealership building was placed in service three years ago and depreciation to-date would be approximately $315,000 under a 39-year schedule. A cost segregation study identifies that 10 percent of the costs qualify for 5-year depreciation. Taking that into consideration, depreciation to-date would be approximately $640,000 instead - a difference of $325,000. The benefit of this difference can be deducted in one year using the automatic accounting change provisions. The IRS has accepted these studies as a result of court decisions in recent years.
The key point here, regardless of whether it is cost segregation or basic depreciation is to make sure that all of your assets are classified correctly. Correctly classifying them will result in the largest amount of depreciation in the shortest period of time, thereby maximizing your tax savings.
Although all of the abovementioned methods of reducing your taxes are legal, they may not all be advantageous to your dealership this year. The best advice is to discuss your options in-depth with a qualified tax professional who understands the nuances of the automotive industry and how tax laws affect your dealership.
OTHER IMPORTANT TAX INFORMATION
Special thanks to Dixon Hughes CPA, Jorg Kaltwasser and to Joseph Magyar, executive, Crowe Chizek and Company, for their assistance compiling this tax information.
Vol 3, Issue 12
