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A review of 2011s economic events and a look at the uncertainties that lie ahead indicate why auto dealerships should get an early start on their year-end tax planning.
Some important tax incentives are in effect only for the 2011 tax year. Some other incentives that are available in 2011 and 2012 could be phased out or eliminated by Congress. With the clock ticking, September 2011 is an ideal month to review the tax incentives that are available now and determine how your dealership and other entities can utilize them.
As dealerships start their tax planning they will be looking back at a year when consumers and businesses have been dealing with an ongoing weak recovery.
Sales of new light vehicles were up 11 percent through July 2011 compared with July 2010, according to Wards Auto. Sales continued to recover from 2008-2009 levels even though the shipment of parts and vehicles from Japan was slowed following the tsunami that struck that country in March 2011. As Japan continues to rebuild, there is reason for optimism on the pace of sales of Japanese vehicles.
But any positive feelings are tempered because dealerships are facing wider concerns about the U.S. and international economies.
In The Tax Relief, Unemployment Insurance and Job Creation Act of 2010, President Obama and Congress extended many of President Bush's earlier tax changes through 2012 - including a maximum individual income tax rate of 35 percent.
However, tax increases could be considered under the Budget Control Act of 2011 . President Obama signed that bill into law on August 2, 2011 after Congress resolved its dispute over temporarily increasing the federal governments debt limit.
Amid these uncertainties, dealerships continue to seek ways to minimize tax obligations to the IRS and to obtain extensions and deferrals on tax payments. Dealerships that do not expect to be profitable in 2011 continue to seek additional ways to return to profitability through streamlining operations as well as by offering additional services or products, based upon demand and expected profit margins.
Here are details on some of the important tax incentives - broken out by areas of operations - that are available in the 2011 tax year (in some cases just for one year):
INVENTORIES
A motor vehicle dealership may treat an entire sales facility from which it routinely conducts on-site sales to retail customers, including any vehicle lot that is routinely visited by retail customers, as a retail sales facility.
By making this election, dealers will not be required to capitalize handling and storage costs incurred at such a facility, as those costs relate to the deemed retail sales facility.
In order to take advantage of this treatment, a dealership will need to elect the safe harbor provisions outlined by the IRS automatic election in Revenue Procedure 2010-44 and prepare a Form 3115 http://www.irs.gov/pub/irs-pdf/f3115.pdf (Application for Change in Accounting Method). During August, Congress was reviewing President Obamas proposed budget for fiscal 2012 which begins on October 1, 2011. The proposal calls for the LIFO (Last In, First Out) method of accounting for inventories to be repealed for the tax year beginning in 2013.
Taxpayers that currently use the LIFO method would be required to write up their beginning LIFO inventory to its FIFO (First In, First Out) value in the first taxable year beginning after December 31, 2011. The LIFO reserve would then be included in income over the following ten years beginning after December 31, 2012.
Many dealerships receive floorplan assistance from manufacturers. Accounting for the assistance as a reduction in cost of the vehicles on books of the dealership can reduce inventory costs of new vehicles, which in turn allows for the deferral of portions of such assistance that pertain to ending new vehicle inventory.
For 2011, the maximum Section 179 expensing amount of $500,000, with a phase-out level of $2 million, will be in effect. For tax years beginning in 2012, a small business taxpayer will be allowed to write off up to $125,000 (indexed for inflation) of capital expenditures subject to a phase-out once capital expenditures exceed $500,000 (indexed for inflation).
Implementing a cost segregation study may help to generate additional cash flow from depreciation deductions. A significant portion of a dealership's real estate could be classified as personal property and depreciated over shorter lives, usually 5 to15 years rather than 39 years.
Planning should be done to ensure the deductibility of additional depreciation from cost segregation and to minimize limitations when these losses are treated from passive activities.
Taxpayers that are not insolvent or bankrupt may be able to elect to exclude from gross income the discharge of qualified real property business debt which comes about from a debt workout agreement with a lender or by changing terms of an existing financing agreement.
If the terms of an existing debt are materially modified in kind or extent, the debtor will be treated as having exchanged the original debt for new debt which will likely, according to the IRS, create debt forgiveness. The cost of excluding the debt discharge is to reduce the depreciable tax basis of the real property that secures the debt.
Dealerships have incentives to make energy efficient changes in their buildings. In general, the expenditures made for energy efficiency are immediately deductible and the cash savings from the investment over time may make the initial investment worthwhile.
COMPENSATION
The December 2010 Tax Act provides for a reduction of two percent in the Social Security Tax (SST) for 2011. The SST provision is not currently available for 2012. Thus, dealerships should consider whether bonuses should be paid out in 2011 to take advantage of this savings.
Incentive payments received as bonuses, prizes or other incentive awards paid directly by the automotive manufacturer or through the dealer to sales persons are not subject to federal withholding tax or federal or state unemployment tax. These payments are not considered self-
employment income and are therefore not subject to self-employment tax. Incentive payments should be reported as "other income" on federal tax returns.
Salaries to S Corporation shareholders who perform significant services to their dealerships should, in general, be equal or greater than the salary paid the highest non-shareholder. Any amount in excess of reasonable compensation could be treated as a distribution to an S Corporation shareholder free of Medicare tax. Dealers should keep in mind that distributions to shareholders must be in proportion to their ownership percentages.
If a dealership operates as an S Corporation or as a Partnership, it is critical that the tax basis is sufficient to deduct losses and that distributions do not exceed the basis in these entities that can trigger reportable gain. Basis can be increased by contributing cash or other assets to the partnership or S Corporation. Special rules apply for S Corporation loans from shareholders, which are repaid shortly after year end.
Choosing the proper business entity is a vital part of long-range tax planning.
ESTATE PLANNING
Tax-related matters on estate planning remain important for many dealerships this year because valuations have remained depressed. Therefore, gifting of fractional interests is a strategy that can be considered for transferring interests of a dealership to the next generation of family members in light of current circumstances.
For 2011 and 2012, the 2010 Tax Relief Act reduced the top rate on the Estate Tax and on the Gift Tax to 35 percent. It also increased the exemptions to $5 million for 2011 with a further increase for inflation in 2012. But unless Congress extends those changes, the top rates will be 55 percent and the exemptions will be $1 million beginning in 2013.
Because of this uncertainty, it is worthwhile to consider 2011 as a year for making one-time gifts to family members. The prospect of more changes in these two taxes makes it very important to have a proper estate plan to ensure that the needs of intended beneficiaries are met.
The information in this article is based on tax laws that were in effect as of mid August 2011.
To take full advantage of these tax-saving strategies, as well as others not listed above, dealers should act now. An MBAF-ERE tax advisor can help navigate the winding tax road ahead, helping to reduce tax liability - and to achieve real business growth.
To contact Daniel Flugrath, email dflugrath@mbafcpa.com; to contact Donald Levin, email dlevin@mbafcpa.com; or call 1-800-239-1474.