Year-End Tax Planning Tips for Dealerships — With a Trump Twist
Your year-end tax planning just got a lot more interesting.
When December comes around, we advise dealerships to revisit their tax management strategies and plan as judiciously as possible for the year (and often years) ahead. This December comes on the heels of Donald Trump’s election to president, and that likely means some significant changes are coming that will affect both your business and personal tax planning. If you were one of the many caught off guard by his win, your tax planning might not be up to speed.
So, this year’s checklist is offered in light of the imminent Trump administration and can help you craft an advantageous and compliant strategy for 2017 and beyond.
Possible Trump administration tax changes
During his campaign, Trump pledged several tax policy changes. It’s still too early to know if all of these will come to fruition or to what degree each will materialize as Congress gets involved, but it’s a safe bet that tax rates will decrease. You might consider taking deductions this year or deferring income to 2017 or later to avail yourself of the likely rate cuts.
Here is what Trump said his administration would change or eliminate:
- Reduce the seven individual tax bracket rates down to just three: 12 percent, 25 percent, and 33 percent (down from 39.6 percent).
- Eliminate income tax for singles who earn less than $25,000 annually and for married couples filing jointly who earn less than $50,000 annually.
- Cut top corporate tax rates from 35 percent to 15 percent.
- Change capital gain taxes to 0 percent, 15 percent, and 20 percent (down from 23.8 percent).
- Eliminate estate taxes.
- Eliminate the alternative minimum tax (AMT).
- Eliminate Obamacare and the 3.8 percent net investment income tax (NIIT).
- Close tax loopholes for the wealthy.
Since these were listed as policy positions for the campaign, the extent and timing of changes is mere speculation. The political process is slow, and proposals often don’t become reality.
Gift and estate taxes
Before the election, this was probably the most time-sensitive of all tax matters for 2016. The estate rules for valuing closely held, private businesses were expected to increase after year-end. If these rules were to be finalized, closely held businesses, when passed to heirs, would likely be valued higher and therefore use more of the current estate exemption amount of $5,450,000.
With Trump vowing to eliminate the estate tax, it is unclear whether these rules will ever be finalized. And if they were to be, it seems they would be ultimately moot if the estate tax is indeed abolished. If you are in the midst of estate planning, we suggest you pause and see how this plays out, if that’s possible in your situation. Talk to your estate planner about the most prudent way to proceed, given the potential outcomes and effects.
You can still save 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 2016 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.
W-3/W-2 and 1099 preparation
New for 2016: IRS forms W-3, W-2, and 1099-MISC with non-employee compensation are all due to both the recipient and the government by January 31, 2017.
In previous years, these forms were due to the recipient at the end of January and due to the government by the end of February. All other 1099 forms (except 1099-MISC forms with non-employee compensation) must be provided to payees by January 31, 2017, and to the government by February 28, 2017. The penalties for late or not filing have been increased to $250 per recipient and $250 per form to the IRS. Failing to file just one required form will likely cost your dealership $500.
We find that many employees responsible for gathering forms W-9 and determining if 1099 reporting is necessary are not properly trained in understanding how the boxes should be marked. With the penalty increase, be sure to train your dealership staff on this important task.
Affordable Care Act
The Affordable Care Act continues to affect dealerships in 2016. There are reporting rules that require additional filings due January 31, 2017. While these are not new for 2016, they are complex and time consuming. Dealerships with at least 50 employees (counting full-time and full-time equivalents) will have to complete Forms 1095-C for all of their full-time employees, together with a related Form 1094-C for the dealership.
Some dealerships with fewer than 50 employees may have to file Forms 1095-B and 1094-B if they partially self-insure employee health care. These filings are complex and require a lot of information, and dealerships will likely seek professional assistance to comply. The non-compliance penalties are quite severe, so be aware of your obligations.
New vehicle inventory planning and LIFO
Many dealerships use the last-in, first-out (LIFO) inventory accounting method for significant tax benefits. Because sales have been strong over the past year and it is harder to obtain inventory from the manufacturer, for some, new vehicle inventories are smaller than they were in the previous year for a lot of dealerships. This could result in significant LIFO recapture income for 2016. You should monitor the new-vehicle inventory in stock at year-end together with the type of vehicles you will have in stock. Work with your advisors on estimating inventory levels to determine potential LIFO adjustments before year-end. This should help you to avoid some unpleasant surprises.
Planning note: Don’t forget that a year-end LIFO estimate must be included on any manufacturer or other financial statement that has 12 months of income reported on it and is provided to a third party.
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 and market-value guides. If you have not made the appropriate elections to make used vehicle write-downs, contact your accountant for assistance.
For several years, used vehicle LIFO made little sense because of low inflation. Many dealers revoked their LIFO election. Dealers not using LIFO, or who revoked LIFO more than five years ago, may receive benefit 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 that if you adopting LIFO for new or used vehicle inventory pools, it is necessary to include a reasonable LIFO estimate on your December 2016 financial statement.
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 your dealership’s stock, as well as 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 2016.
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. 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.
Section 179 expense and bonus depreciation
The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) was passed by Congress late in 2015 and had more long term implications than prior end of year tax laws. For 2016, the Section 179 first-year expense deduction is at $500,000. This allows a dealership to purchase up to $500,000 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 $2,010,000, the amount of available Section 179 expense begins to phase out. At $2,510,000 of expenditures, it is completely phased out. Additionally, fifty percent bonus depreciation is still in effect for tax year 2016. This is not subject to taxable income limitations, unlike Section 179 depreciation.
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.
For 2016 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. Considering the possibility of lower tax rates in the future, it may make sense to delay dividends until we see what tax rate changes may occur under the new Trump administration.
Officer note payable repayments
If your dealership or another business has generated tax losses in the past, review current-year loan repayments made to shareholders. If prior-year losses have been taken based on money borrowed from shareholders, the repayment of such loans may create taxable income to the shareholder in the year of repayment. Review your loan activity in 2016 and consult with a tax advisor to determine if an unwelcome tax surprise may result.
Joint taxpayers with combined earned income in excess of $250,000 will be subject to an additional 0.9 percent Medicare tax in 2016. Consider your wages for 2016 to determine if it is possible to reduce your wages to below this amount. For many S corporation dealership owners who are planning on receiving wages more than a reasonably-low amount, 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.
Recognize income in 2016 or 2017
Consider postponing income to the following year for tax deferral, if possible. Taxpayers with income in excess of $400,000 should review current-year income compared to expected income for 2017 to see if taxable income should be maximized in 2016 or deferred. Married taxpayers should expect income over $467,000 to be subject 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 about $415,000. If Trump reduces tax rates as pledged, it may be advantageous to defer income where possible.
Cost segregation of buildings or improvements
Any building acquisition, construction project, or renovation which costs more 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 accelerate your tax deduction for depreciation. The tax depreciation may be greater than the book depreciation methods used for your financial statements.
With many of the 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 such facility upgrades.
Many manufacturers offer some type of assistance payments to encourage dealership improvements. The IRS issued guidance that generally requires such payments to be treated as taxable income, as opposed to offsetting building costs. Cost segregation of the building or improvement may be the best alternative to offset the income reporting for these assistance payments.
Capitalize or expense dealership repairs?
Generally, most dealerships’ fixed assets are capitalized and depreciated over a number of years. The regulations in place now may allow dealerships to expense items that you would have depreciated in past years. Effectively implementing these capitalization policies will allow the dealership to expense items that cost less than $2,500, and may allow for expensing items up to $5,000. This can benefit a dealership and should be looked at closely.
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 doesn’t 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 2016. 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. The additional 3.8 percent tax does not apply to net rental income generated from the dealership renting its building from the dealership’s owner.
Harvesting capital gains or losses
If you have unrealized gains or losses in your stock portfolio, there is a potential to use them for 2016. If your income is low for 2016, 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 2016, consider recognizing losses to reduce your tax liability and then repurchase similar holdings. Because of the 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, please let your tax advisor know, as the sale has to occur in 2016. Likewise, if you already have carryover capital losses from previous years, you could harvest gains in order to offset those losses, as 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, such as deducting the higher, appreciated value of the stock as opposed to its original cost basis. Plus, there is no income recognition on the donation of the appreciated stock.
Review customer accounts receivable to determine which past-due accounts are uncollectible. You can claim deductions for bad debt expense. Remember that uncollectible factory incentives, rebates, and other receivables can also be written off.
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. Such expenses should be reviewed by dealership personnel to determine meals and entertainment that may be 100 percent deductible.
Itemized deductions and dependent exemptions
Higher-income taxpayers with income over approximately $311,000 (married) or $259,000 (single) will lose some of their dependent exemptions, as well as itemized deductions. At certain income levels, this can result in a loss of up to 80 percent of itemized deductions. This means that 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.
Review January expenses and other chargebacks
Taxpayers are usually encouraged to review their expenses paid in January of 2017 to determine if they are properly deductible in 2016. With the significant tax rates many dealers will face this year, you will want to review all January and February invoices to find those that can be deducted in 2016.
Maximize contributions to your 401(k) and other retirement plans
Many dealerships have instituted retirement plans so employees can make contributions to reduce the employees’ 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 your 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. The wages earned by the children could be contributed to a Roth IRA for lifetime tax-free growth.
When preparing your Forms W-2, don’t forget to include demo income benefits for sales persons and other managers that must be included in taxable income.
How we can help
Our dealership industry tax practitioners can help you both comply and optimize tax savings for your business and yourself. We can work with you to develop a strategic tax plan and make sense of complex regulations and rules.