Year-End Planning May Reduce Dealer Taxes
Developing a tax planning strategy to address some of this year’s tax issues will help position your dealership to adapt to the changes in the industry, as well as save money. Some strategies may require action by the end of the year, while others can be postponed until 2010. In either case, developing a plan will help you operate your business with financial efficiency and reduce the year-end workload on your people.
“It has been a challenging year of unprecedented change in the dealership industry. With the end of 2009 approaching, it is important to prepare for year-end and understand the tax issues affecting your particular dealership,” says Dave Wiggins, a dealership principal with LarsonAllen.
New vehicle inventory planning
Dealerships that use the last in, first out (LIFO) inventory accounting method should closely monitor how much and what type of new vehicle inventory they will have in stock at year-end. Many dealers this year will have low inventory levels either due to the Car Allowance Rebate System (CARS or “cash for clunkers”) or reduced inventory planning with the past year’s sluggish economy. Although this may save you floor plan interest costs, this could result in unexpected LIFO income recapture and additional taxes due April 15.
If your LIFO recapture will be significant this year, you may want to consider discontinuing your use of LIFO. The IRS generally allows dealerships to elect to pick-up the LIFO reserve into income on a pro rata basis over a four year period. For other options available to dealers to lessen the tax exposure from LIFO or to view example 2009 LIFO projections, read our story, “Clunkers Program Results in Potential LIFO Mess.”
Corporation and personal operating loss carrybacks
Last year Congress allowed losses generated in 2008 to be carried back to the five previous years to offset income in prior years. Unfortunately, they didn’t allow this for businesses with gross receipts in excess of 15 million dollars. This cap effectively eliminated most dealers from receiving this tax benefit.
The good news is that, because of recent tax law changes, losses generated in 2009 will be available for carryback to the prior five years and won’t be limited by the $15 million cap. Your dealership may benefit from carrying back losses and bunching expenses this year (and/or reducing income) to increase 2009 losses.
For more information on the expanded business loss carryback opportunities for large and small enterprises, read our story, “Homebuyers and Businesses With Operating Losses Get Boost in New Tax Bill.”
Section 263A (UNICAP) inventory changes
The uniform capitalization rules under Internal Revenue Code (IRC) Section 263A (UNICAP) require that retailers add certain costs to inventory. Based on the IRS’s interpretations, costs that must be added to inventory (and not expensed) could increase significantly. You will need to review your dealership’s position on this issue at year-end and revisit it at the end of next year based on additional guidance from the IRS.
Read our story, “Dealers Face Significant Tax Cost if IRS Interpretation of UNICAP Sticks” to learn about the recent IRS field directive, the stand down period, and possible help from the National Automobile Dealers Association (NADA).
Possible S corporation opportunity
With the significant losses dealers have incurred this year, some C corporation dealerships may find themselves with large enough loss carryovers to allow them to convert to S corporations with minimal tax impact from LIFO.
Recognize income in 2009 or 2010
Most advisors believe tax rates will increase by 5 to 10 percent in 2010 or 2011. Tax planning is more critical than ever. In some situations, it may make sense to recognize income in 2009 or 2010 before rates increase.
S corporation or partnership losses
If you own an interest in a partnership or S corporation, you may need to increase your tax basis in the entity through a cash contribution, so you can deduct a loss from it this year. If a dealership is reporting a current loss, its shareholders should determine if they have the tax basis needed to benefit from this loss in 2009.
Self-rental income
If you lease real estate to your own business entity, the passive activity loss rules present a considerable threat. If your Form 1040 has a mix of positive and negative rental activities, carefully assess the passive loss risk needs. By making the proper election to group passive activities, you can offset your rental losses with your dealership profits to avoid having them disallowed.
Used vehicle write downs to market
If your dealership is not on used vehicle LIFO, you may be able to adjust the cost on your books of used vehicle inventories down to their current market value. To do so requires that you have made the correct elections in prior year returns. Such market value adjustments should be based on industry guidelines and market value guides that are consistently followed on an annual basis.
Used vehicle LIFO
For the past several years used vehicle LIFO made little sense because of declining used vehicle values, and many dealers elected off this method of accounting. Dealers that have not been on used LIFO for more than five years are eligible to re-elect to use this method in 2009. “At some point we all knew used vehicle prices would start climbing again; 2009 appears to be a year of inflation in used vehicle prices,” says Wiggins. Some estimates of inflation in used vehicles could be as high as 7 percent. “Remember, LIFO generally reduces income by the rate of inflation, so 5 percent inflation could generate savings of 5 percent of your used vehicle inventory value,” he explains.
S corporation owner’s health insurance deduction
Based on a 2008 directive from the IRS, it is important to have the health insurance premiums of an S corporation shareholder either paid directly or reimbursed by the corporation. Further, those premium payments must be added as income to the owner’s W-2. The income added on the W-2 for this will not require FICA/Medicare withholding. This allows the individual owner to then claim a 100 percent offsetting 1040 deduction for the health insurance costs.
Tax rate increase and capital gains
Presently, capital gains and qualified dividends are taxed at a rate of 15 percent. The Obama administration’s budget proposes to increase that rate to 20 percent in 2011. You can avoid this tax increase by accelerating capital gain sales and dividends into 2009 and 2010. Sales of real estate and closely held corporate stock to family members are examples of transactions that would be better placed in 2009 or early 2010 than in the next few years.
For those receiving payments on older installment sales, you should review actions you might take before year-end that can accelerate the remaining gain into 2009 or 2010. Find out more about this increase in our story, “President’s Proposed Budget Increases Taxes for Higher Income Individuals.”
Cost segregation of buildings or improvements
Any building acquisition, construction project, or renovation greater than $500,000 can usually defer tax liability and provide a cash flow benefit through some form of
cost segregation study. These studies segregate the various costs of the structures and land improvements and depreciate some elements more quickly, which can significantly accelerate your tax deduction for these projects.
Compensation: wages versus dividends
Many C or S corporation shareholders, who own dealerships generating taxable losses in 2009 and are also employees of the corporation, may want to consider reducing their wages and take dividends instead. If the wages being paid to the shareholder are not benefiting the corporation as an expense, shifting from wages to dividends reduces the current year income and Social Security taxes. (The IRS requires you to continue paying “reasonable” wages for the work being done.)
Parts inventory adjustments
Make sure to reconcile your parts inventory balances on your books with the parts inventory counter pad annually. This is normally done if a physical parts inventory is taken, but does not require a physical parts inventory. Often reconciling the two inventory balances can result in decreased taxable income if the counter pad amount is less than your general ledger.
Receivable write-offs
Review past due customer accounts receivables and determine those that appear to be uncollectible. Write off such accounts to bad debt expense. Remember that uncollectible factory incentives, rebates, and other receivables can all be written off.
Categorize meals and entertainment expenses
Many dealerships lump all meal and entertainment expenses into one account. As a result, most of these expenses will only have half of the expense deducted on the company’s tax return. Various expenses are deductible at different rates (100 percent, 80 percent, and 50 percent). Make sure to review this area to properly categorize your expenses for tax purposes.
Loan repayments to shareholders
If the dealership or another business has generated taxable losses in the past, review current year loan repayments made to shareholders. If prior year losses have been taken based on money loaned by shareholders, the repayment of such loans may create taxable income to the shareholder in the year of repayment. Review your 2009 loan activity to determine if it has created any taxable income to you.
Review January expenses and other chargebacks
Dealers should make sure that finance, service contract, and other chargebacks received in January 2010 are recorded in 2009. Such chargebacks and other expenses may not be received until after the financial statement and month-end are closed, but should be recorded in completing your income tax returns so that you receive the deduction in the current year, not 2010. In 2009, it may also be possible to deduct employment taxes that will not be paid until 2010 on bonuses and other salary accrued for the 2009 tax year.
Maximize contributions to 401(k) and other retirement plans
Many dealerships have retirement plans set up so employees can make contributions that are not included as income. Most of these plans have limits on the amounts that dealership officers and owners may contribute (and sometimes require that such contributions are returned at the end of year); however, owners frequently do not contribute as much as they are allowed. Contact your retirement plan administrator to verify you are maximizing your contributions to these accounts.
Gift and estate taxes
You may give $13,000 in 2009 to an unlimited number of individuals to reduce the costs of the 45 percent federal estate tax to your heirs. (You cannot carry over unused gift exclusions from one year to the next.) For those with children or grandchildren that may be facing future education costs, we recommend you evaluate the potential estate tax savings available from an accelerated Section 529 plan gifting strategy.
These are only a few of the considerations to keep in mind at year-end that could reduce your taxes. Each dealer’s financial situation is unique, so the best plans are specifically tailored to meet your needs.
For more information, contact Dave Wiggins at dwiggins@larsonallen.com or 314-336-3816, or a dealership principal in your region.