Certain dealership accounting practices cause unnecessary taxable income. Dealers and their CPAs should consider the effects.
My colleague, Jorg Kaltwasser and I led a discussion at a conferences for automobile dealerships, addressing tax strategies that specifically relate to automobile dealers. Our presentation was limited to 60 minutes followed by a 30 minute Q and A. We could have gone for much longer. Here's some of what we discussed.
Cost Segregation - Faster write-offs of dealership building costs are usually available when a cost segregation study is performed. Dealership buildings are generally depreciable over a lengthy 39-year life. A cost segregation study identifies certain costs in the building process that would be depreciable over a shorter period of time, typically five, seven or 15 years.
These would include land improvements and costs qualifying as tangible personal property such as certain electrical work. These costs normally just become part of a lump-sum building cost that is depreciated over 39 years. The cost segregation study is best performed by an expert with an engineering background who understands the construction process. George B. Jones Co. has aligned ourselves with such an expert.
In a typical new dealership project it is estimated that approximately 22% of building costs can be classified as 15-year property and approximately 8% of building costs can be classified as 5-year property for depreciation.
The conversion of these costs from a straight 39-year depreciation to five-, seven- and 15-year depreciation categories provides considerable cash flow advantages because the larger deductions reduce your income taxes. Cost segregation studies can be performed on properties that are a few years old as well as for new construction.
Class Life 57.0 Property - Overlooked by many dealerships is the ability to depreciate certain furniture and equipment used in the dealership over five years rather than seven years. This is an opportunity not only overlooked by many dealers, but their CPAs as well.
Simplified Procedures to Change Depreciation Lives - Automatic Accounting Changes are made available by IRS to change depreciable lives on property. In many instances, they can still be applied for calendar year 2000 companies.
Inventory tax saving opportunities
Floor plan interest assistance payments received from the domestic manufacturers and a few import manufacturers offer an excellent tax deferral opportunity. Dealers generally record these payments as income or a reduction of interest expense.
In reality, the payment is a rebate on the vehicle and can reduce the cost of the car rather than treated as income. The “interest assistance” on vehicles still in inventory at year-end is deferred for considerable tax reductions.
For example, the General Motors rebate amount is generally 1.5% of base MSRP. On a $10 million inventory there is approximately $150,000 in rebates that should reduce the cost of the inventory. Assuming that $40,000 of the rebate has not been collected from the factory yet at year-end, there is $110,000 in income that has been recorded unnecessarily. If inventory costs were reduced by the rebates rather than reported as income, a $48,400 tax deferral would result assuming a 44% combined federal and state rate.
The deferral remains in place as long as inventory levels remain at the same levels and rebate programs continue. An election for an accounting change properly submitted to the IRS is required.
Certain other dealership accounting practices cause unnecessary taxable income. Dealers and their CPAs should consider the effects of various packs and charges to inventory, treatment of cooperative advertising charges, overvaluing of trade-ins, etc.
Last in, first out update
Used Vehicle LIFO issues - The day before our conference, the IRS issued an “Alternative” LIFO method for used vehicles. We found the method to be manageable. This should clear up much dealer confusion in this area.
Parts LIFO - In limbo due to the replacement cost issue.
LIFO conformity and record-keeping requirements - Compliance with LIFO conformity rules (i.e., the required use of LIFO for financial reporting) is of utmost importance. Failure to maintain LIFO computation records can lead to termination.
Tax compliance issues
Demonstrators - The use of a demonstrator by a dealership employee is taxable income to the employee subject to payroll reporting unless the salesperson exception is met. The exemption is available for certain demonstrator use by qualifying full-time salespersons subject to restrictive rules and substantiation requirements.
Failure to meet all the requirements can lead to substantial tax assessments against the dealership. Taxable use of a demonstrator by other employees is generally valued under the annual lease value method or may be valued by other methods in limited circumstances.
Cash reporting - IRS cash reporting rules require that actual cash received by a dealership from customers in excess of $10,000 be reported to IRS on a form 8300. The dealership must have systems in place to assure these filings are made as IRS periodically checks compliance. There are unique definitions of what is actually “cash” as the term applies to these rules. Have you checked your cash reporting compliance lately?
Likely tax entities for dealerships
LLC - Limited Liability Companies are often the entity of choice for dealership operations. The use of partnership taxation provides pass-through of income and loss to owners as does an S Corporation and similarly provides a single level of income tax as well as certain liability protection.
The avoidance of some S Corporation traps and the flexibility available through the use of partnership rules generally makes an LLC more desirable than the commonly used S Corporation. A single member LLC is disregarded for federal tax purposes however can provide useful legal protection for certain activities.
S Corporation - Dealerships may now own qualified Subchapter S subsidiaries allowing a holding company structure or multiple corporations to be treated as one S corporation for tax purposes. This is often times the preferred structure when discounting of receivables among related companies is part of the business structure.
C Corporation - Should generally be avoided by automobile dealerships. In profitable C corporations, there are two common IRS issues of which dealers should be leery. The first is unreasonable compensation; the second, excess retained earnings. Neither of these is usually an issue with S corporations since there is generally only one level of tax.
Don Ray is the president of the George B. Jones Companies, a national accounting and consulting group for retail automobile dealers. If you would like to know more about tax issues facing dealers, contact him at 800-323-6726 and [email protected].