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Year-End Tax Preparation and Planning Checklist for Dealerships
As we approach a new year, the final days of 2014 are the perfect time to take an overall look at your dealership to plan for year-end and the year ahead. To date, Congress has not enacted any tax law changes for the 2014 tax year. Many tax professionals, including us, expect Congress to pass some tax legislation either at or after year-end. We expect some of the changes will be retroactive to January 1, 2014. We believe the 2014 tax provisions will increase the Section 179 or bonus depreciation limits discussed below and also reinstate some expired tax provisions that have been reinstated annually.
Following are some tax planning strategies that proactive leaders can take now and in 2015 to create opportunities for your dealership.
New vehicle inventory planning
Dealerships that use the last-in, first-out (LIFO) inventory accounting method should closely monitor the new vehicle inventory in stock at year end, together with the type of vehicles they will have in stock in 2015. Work with your advisors on estimating inventory levels to determine potential LIFO adjustments before December 31, 2014.
S corporation or partnership losses
If you own an interest in an S corporation, you may need to increase your tax basis in the entity so you can deduct a current year tax loss against other income. If you are reporting losses, you should review the tax basis in the stock of your dealership and the tax basis in loans to the dealership to ensure that you have sufficient tax basis to deduct the loss on this year’s personal income tax returns. These strategies may require adjustment prior to the end of 2014.
Do you lease real estate to your own business entity? If so, the passive activity loss rules present a significant threat. If your Form 1040 has a mix of positive and negative net income amounts among your rental activities, the passive loss risk needs to be carefully assessed. Grouping rules may allow you to offset your rental losses with your dealership profits to avoid disallowance of the losses.
Used vehicle write-downs to market and LIFO
If your dealership is not determining used vehicle inventory using LIFO, you may be able to reduce your used vehicle inventories from cost value to market value (if the market value is less). But to do so, you must have made the correct elections in prior year tax returns. Such market value adjustments should be based on industry guidelines and market value guides. If you have not made the appropriate elections to take used vehicle write-downs, contact your accountant for assistance.
For several years, used vehicle LIFO made little sense due to low inflation, and many dealers revoked their LIFO election. Dealers not using LIFO, or who revoked LIFO more than five years ago, may receive benefits if they adopt this year. Remember, LIFO generally reduces income by the rate of inflation; 5 percent inflation could reduce taxable income by 5 percent of your used vehicle inventory value. If you are on used vehicle LIFO, you are prohibited from taking used vehicle write-downs. The LIFO benefit is additive each year, versus used vehicle write-downs, which generally represent a one-time deduction that carries forward.
Keep in mind, if you want to consider adopting LIFO for new or used vehicle inventory pools, it is necessary to include a reasonable LIFO estimate on your December 2014 financial statement.
Affordable Care Act
The Affordable Care Act (ACA) will affect many dealerships during 2015. Several facets of this law affect its implementation and effective dates and there are significant penalties for noncompliance, so we recommend you contact your accounting firm to assist in determining the impact of ACA on your dealership.
For 2014 and beyond, dividends are subject to federal tax rates of up to 23.8 percent. Unlike past years when rates were lower, there is no urgency to take reinsurance company or other dividends this year. Individuals having low tax rates this year or in future years should take dividends in low tax-rate years.
Joint taxpayers with combined wages in excess of $250,000 will be subject to an additional 0.9 percent Medicare tax in 2014. Consider your expected wages for 2014 and 2015 and determine if it is possible to reduce your wages to below this threshold. For many S corporation dealership owners, if you are taking reasonable wages, it may be worthwhile to determine whether you can reduce wage payments and instead take S corporation distributions to avoid this additional tax. Wages, however, must be reasonable for the services provided.
S corporation owner’s health insurance deduction
Based on a directive from the IRS, it is important that the corporation pay the health insurance premiums of an S corporation shareholder or reimburse the shareholder for premiums paid personally, in accordance with a corporate plan. Furthermore, those premium payments must be added to the owner’s Form W-2 as taxable wages. This allows the individual owner to claim a deduction for the health insurance costs. The income added on forms W-2 is not subject to FICA or Medicare. The ACA may require that the health insurance be provided as part of an employer group health insurance plan.
Recognize income in 2014 or 2015
Consider postponing income to the following year for tax deferral. Taxpayers with income in excess of $400,000 should review current-year income compared to expected income for 2015 to determine if taxable income should be maximized in 2014 or deferred. Married taxpayers should expect income over $450,000 to be subjected to the highest federal tax rate of 39.6 percent. The effective rate, due to phase-outs of deductions for high-income individuals, may be higher. For singles, the threshold income is $400,000.
Cost segregation of buildings or improvements
Any building acquisition, construction project, or renovation greater than $500,000 can usually defer tax liabilities and provide a cash flow benefit through some form of a cost segregation study. These studies separate the various costs of the structures and land improvements into different depreciation methods and shorten the depreciable life categories, which accelerates your tax deduction for depreciation. The tax depreciation may be greater than the book depreciation methods used for your financial statements.
With many manufacturer programs requiring facility image upgrades, cost segregation or repair studies might be the silver lining that allows you to claim current tax benefits for the significant amounts expended on facility upgrades.
Capitalize or expense dealership repairs?
Generally, most dealership fixed assets are capitalized and depreciated over a number of years. New regulations effective this year may allow dealerships to expense items that you would have depreciated in past years. Such determinations are very technical and should be made by professionals who specialize in the automotive industry, including engineers familiar with the technical requirements. Many dealerships will need to implement a capitalization policy prior to the beginning of the next tax year so more items can be expensed in the new year. Effectively implementing these capitalization policies will allow the dealership to expense items that cost less than $500, and may allow for expensing of items up to $5,000.
Section 179 expense and bonus depreciation
For 2014, the Section 179 first-year expense deduction is scheduled to be reduced to $25,000. This is down significantly from the $500,000 allowed in recent years. The deduction allows a dealership to purchase up to $25,000 of new or used equipment, furniture or fixtures by year-end and expense the entire purchase price to the extent of taxable income. Once total expenditures for such assets exceed $200,000, the amount of available Section 179 expense begins to phase out.
Planning note: We believe that the Section 179 expense limit will be increased for 2014 and 2015. Unfortunately, we will not know for sure how much will be allowed until the very end of the year or sometime next year (and made retroactive to 2014). Bills in Congress suggest that the Section 179 expense amount may be between $200,000 and $500,000. Planning for use of this unknown amount is difficult at best.
In prior years, in addition to Section 179 expensing, there has been the ability to write off 50 percent of all new equipment in addition to the Section 179 expense allowance. Unfortunately, there is currently no bonus depreciation for 2014.
Similar to Section 179, bonus depreciation may be reinstated for 2014 or 2015, but we will not know until legislation is passed. Again, planning for best use of this is difficult at best.
Parts inventory adjustments
Make sure to reconcile your parts inventory balances on your books with your parts inventory counter pad. This is normally done if a physical parts inventory is taken, but it does not require a physical inventory. Reconciling the two inventory balances often results in decreased taxable income. Consider writing off obsolete inventories before year-end.
Net investment income tax
The net investment income tax is 3.8 percent again for 2014. For dealers at the top marginal tax rate, this could equal a tax rate of 43.4 percent. This is a tax on interest, dividends, rental income, capital gains, and passive income. Through the use of grouping elections, changing interest rates on shareholder loans, and other planning to reduce capital gains, it may be possible to reduce your income subject to this 3.8 percent additional tax. In a change from what many expected, the additional 3.8 percent tax does not apply to net rental income generated from the dealership renting its building from the owner of the business.
Harvesting capital gains or losses
If you have unrealized gains or losses in your stock portfolio, it may be possible to use them for 2014. If your income is low for 2014, it might make sense to recognize gains, pay the tax at a lower rate, and then repurchase similar holdings. If your income is already quite high for 2014, consider recognizing those losses to reduce your tax liability and then repurchase similar holdings.
Due to wash sale rules, you have to be careful. However, there are ways to harvest losses without triggering the wash sale rules. If this is applicable to you the sale has to occur in 2014, so let your tax advisor know you are considering it. Likewise, if you already have carry over capital losses from previous years, you could harvest gains in order to offset those losses, since you can only deduct a net loss of $3,000 per year.
Charitable donations of appreciated stock
Another way to minimize tax on capital gains is to directly donate appreciated stock. There are multiple benefits with this, such as being able to deduct the higher, appreciated value of the stock as opposed to the original cost basis of the stock. There is also no tax on the transaction.
Review customer accounts receivable to determine which past-due accounts are uncollectible. You will be able to claim deductions for bad debt expense. Remember that uncollectible factory incentives, rebates, and other receivables can also be written off.
Meals and entertainment expense
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. Such expenses should be reviewed to determine which meal and entertainment costs are 100 percent deductible.
Itemized deductions and dependent exemptions
Taxpayers with income over $300,000 (married) or $250,000 (single) will lose some of their dependent exemptions and itemized deductions in 2014. At certain income levels, this can result in a loss of up to 80 percent of itemized deductions. Some dealers should consider accelerating or deferring a portion or all of their charitable contributions and/or state income tax payments normally made before year end.
Watch out for officer note payable repayments
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 loan activity in 2014 and consult with a tax advisor to determine if an unwelcome tax surprise may result.
Review January expenses and other chargebacks
Taxpayers are usually encouraged to review their expenses paid in January to determine if expenses are properly deductible in 2014. With the significant tax rates many dealers will face this year, be sure to review all January and February invoices to determine which expenses can be deducted in 2014.
Maximize contributions to your 401(k)
Many dealerships have instituted retirement plans so employees can make contributions to reduce the employee’s wages. Most of these plans have limits on the amounts that officers and owners of the dealership may contribute (and sometimes require that such contributions are returned at year end). However, owners frequently do not contribute the maximum amount. After the year ends, the opportunity to contribute more is missed. Contact your retirement plan administrator to determine if you can contribute additional funds to these accounts.
Compensate children for work
If your children provide, or could provide, services to your dealership, consider the benefits of paying them for their services. This may introduce them to the idea of working to earn compensation. At the same time, it may reduce your overall family tax burden based on tax rate differences. Wages earned by children can be contributed to a Roth IRA for lifetime tax-free growth.
Health care credit
If your business has fewer than 25 full time employees with an average pay of less than $50,000, and you provide your employees with some level of health insurance, you may be entitled to a credit of up to 50 percent of the premiums the company pays. The calculation is complicated, but so be sure to provide this information to your tax preparer.
Gift and estate taxes
You can reduce gift and estate taxes by making gifts covered by the annual gift tax exclusion before year-end. You may give $14,000 each to an unlimited number of individuals in 2014 to reduce the costs of a 40 percent federal estate tax to your heirs. However, you cannot carry over unused gift exclusions from one year to the next. For those with children or grandchildren that may be facing future higher education costs, talk to an advisor about designing a gift strategy that uses tax-free Section 529 college savings plans.
How we can help
This checklist is based on tax laws currently in place. As we get future tax law changes that will affect your 2014 or 2015 preparation and planning, we will keep you updated.