The last major tax reform legislation was passed in 1986. Since then, the tax rules – Internal Revenue Code amendments, regulations, procedural guidance and court case law – have morphed into a complex system for taxpaying dealers. The recently signed bill is a significant modification to the existing system, and the consensus is clear. Most businesses expect their income tax expense to decrease, including dealerships.
Though there are many moving parts in the new tax law with the potential to affect businesses and individuals to varying degrees, this article highlights what we consider 10 of the most significant changes for dealerships.
1 - Individual tax rates and corporate tax rates
The final bill settled on keeping the same number of individual tax brackets as in current existence, seven. However, the new tax law reduces individual income tax rates to 10, 12, 22, 24, 32, 35, and 37 percent, and raises the income levels subject to each tax rate. These rates apply to tax years beginning after December 31, 2017 and beginning before January 1, 2026, unless subsequently extended by future legislation.
On the corporate side, the current graduated tax rate was removed in favor of a flat 21 percent rate for tax years beginning after December 31, 2017.
Planning tip: As with most years, the overall theme to year-end tax planning in connection with a tax rate reduction calls for dealers to accelerate deductions into the current year and defer revenues into the next year, to recognize permanent tax savings. One way to do this is to consider implementing certain tax accounting method changes on a dealership’s 2017 tax return.
2 - Alternative minimum tax
The original goal was to completely repeal the alternative minimum tax (AMT) for both individuals and corporations. Unfortunately, while the final bill removed the proposed full repeal of AMT for individuals, it replaced it with an increased exemption from $86,200 to $109,400 and the phase out threshold increased from $164,100 to $1,000,000 for married filing join taxpayers. The exemption amount for single taxpayers increased from $55,400 to $70,300 and the phase out threshold increased from $123,500 to $500,000.
On the other hand, corporate AMT is fully repealed under the final bill for tax years beginning after December 31, 2017, which is beneficial to dealerships taxed as a C corporation. Any AMT tax credit carryforwards will offset the taxpayer’s regular tax liability and is refundable, within limits, starting in 2019.
3 - Pass-through income deduction
Aligning with a reduced corporate tax rate, Congress provided pass-through entities with a deduction for a percentage of their taxable income. Starting in 2018, a deduction will be allowed for taxpayers who have “qualified business income” (QBI) from a partnership, S corporation, or sole proprietorship, subject to limitations. The 20% deduction is limited to the lesser of (1) 20% of their pass through business income or (2) the greater of (a) 50% of the W-2 wages paid in the qualified trade or business, or (b) the sum of 25% of W-2 wages, plus 2.5% of the unadjusted basis of all qualified property. This deduction applies for tax years beginning after December 31, 2017 and beginning before January 1, 2026.
4 - Standard deduction, charitable contributions, and the Pease limitation
Personal exemptions are removed in the bill in favor of a higher standard deduction effective for tax years beginning after December 31, 2017 and beginning before January 1, 2026. The new standard deduction amounts will be $24,000 for married filing joint or surviving spouse, $18,000 for an unmarried individual with at least one qualifying child, and $12,000 for single filers. Charitable contributions – which, under old law, were limited to 50% of a taxpayer’s AGI – will now be limited to 60% of AGI effective for tax years beginning after December 31, 2017 and beginning before January 1, 2026. The bill will also repeal the current 80 percent deduction for certain contributions to universities made in connection with athletic seating rights.
Planning tip: For dealers currently obligated to make contributions to a university in connection with seating rights, consider making these payments before year-end. The overall limitation on itemized deductions referred to as the Pease limitation will be suspended for tax years beginning after December 31, 2017 and beginning before January 1, 2026. This limitation essentially reduced the value of certain itemized deductions for high income taxpayers by 3% for every dollar over the taxable income limit. The phase out was capped at 80% of the total value of itemized deductions.
Planning tip: If you are considering making any significant charitable contributions near year-end, you should consult with your tax adviser to determine whether it is more beneficial to make the contribution in 2017 or 2018.
5 - State and local tax deduction
A very impactful change included in the final bill is the limiting of the deduction available for sales, income, or property taxes paid to state or local tax authority to $10,000 ($5,000 for a married taxpayer filing a separate return) for tax years beginning after December 31, 2017 and beginning before January 1, 2026. This limitation does not apply to any of the aforementioned taxes paid or accrued in connection with carrying on a trade or business.
The bill specifically includes a provision that disallows prepaying state or local income tax for a taxable year beginning after December 31, 2017. Any amount paid in a taxable year beginning before January 1, 2018 shall be treated as being paid on the last day of the tax year for which the tax applies.
Planning tip: Dealers with fourth quarter estimated tax payment requirements should consider paying before year-end. For states that allow taxpayers to purchase state credits in relation to making contributions towards Scholarship Granting Organizations (SGOs) – which effectively converts a state income tax deduction to a charitable contribution for federal purposes – this will provide future opportunity to see some degree of benefit for what would otherwise be a state income tax deduction, limited under the new bill based upon the respective state’s rules.
6 - Depreciation changes
The bill includes a provision that allows for 100 percent expensing through bonus depreciation of certain business assets placed in service after September 27, 2017 through December 31, 2022. The amount of bonus depreciation allowed is then phased down over four years as follows starting: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026. The requirement that the property be new was also removed and replaced with a requirement that the property simply be new to the taxpayer – an impactful distinction.
However, in order to preserve full deductibility of floorplan interest expense, dealers received a trade-off. The ability to exclude floor plan interest expense from the interest expense limitation (discussed below) also means that qualified property for bonus depreciation purposes now excludes any property used in a trade or business that had floor plan financing indebtedness not subject to the interest expense deduction limitation.
Nonetheless, the bill includes some additional changes that have the potential to benefit many dealers. For example, Section 179 expensing limits will be increased to $1,000,000, with the phase out threshold being increased to $2,500,000 with both thresholds subject to inflation increases for tax years beginning after December 31, 2017. Furthermore, the definition of qualified property is expanded to include improvements to roofs, heating, ventilation, and air-conditioning property, fire protection and alarm systems, and security systems made to nonresidential real property if placed in service after the date such real property was first placed in service.
Planning tip: If you are considering starting, or can delay completing projects in progress involving improvements to existing buildings for roofs, heating, ventilation, and airconditioning property, fire protection and alarm systems, and security systems until 2018, you may have the opportunity to take accelerated depreciation on these projects.
7 - Interest expense deduction limitation
The bill also includes a provision that limits the deduction for interest expense incurred by a trade or business to the sum of business interest expense, interest income, 30% of the adjusted taxable income, and the floor plan financing interest expense of a taxpayer for the year. For tax years beginning before January 1, 2022, adjusted taxable income will be computed without regard to depreciation, amortization, or depletion expense. Adjusted taxable income is otherwise generally defined as a taxpayer’s taxable income without regard to any income, gain, deduction or loss not properly allocable to the trade or business, any business interest expense or business interest income, and any net operating loss.
Real property trades or businesses, including rental property activities that qualify as a trade or business, may elect out of the interest deduction limitation if that trade or business uses the alternative depreciation system, which generally results in longer, slower depreciation deductions. Any interest not deductible for any tax year shall be carried forward indefinitely, and treated as business interest paid or accrued in the succeeding tax year.
8 - S corporation conversion to C corporation
Regarding the reduced corporate rates, Congress anticipated the possibility of S corporations looking to convert to C corporations. To simplify this conversion, an S corporation that qualifies as an eligible terminated S corporation that pays distributions during the post-termination period is treated as having paid such distributions proportionately from any remaining S corporation accumulated adjustment account and any accumulated earnings and profits of the new C corporation. An eligible terminated S corporation is one that revokes its S corporation election within two years of the bill’s enactment date, and has the same shareholders with identical ownership percentages as of the date of the bill’s enactment.
9 - Like-kind exchanges
Under the new law, like-kind exchanges are limited to only exchanges involving real property that is not primarily held for sale. This new limitation applies to exchanges completed after December 31, 2017; however, a transition rule allows like-kind exchange treatment for any property disposed of in an exchange on or before December 31, 2017, or for any property received by a taxpayer in an exchange on or before the same date. This exception generally allows for like-kind exchanges already in process to still take advantage of the current like-kind exchange rules.
For dealers, this means that like-kind exchanges involving franchise rights are no longer available.
10 - Estate and gift taxes and generation-skipping transfer tax
The law doubles the base estate and gift tax unified credit exclusion to $10 million, effective for decedents dying and gifts made after 2017 and before 2026. The bill also increases the GST exemption to $10 million. This effectively increases the inflation-adjusted exclusion and exemption amounts to $11.2 million ($22.4 million for a married couple) for 2018.
These increased exclusion and exemption amounts will provide planning opportunities for dealers looking to transition their estate in the coming years.
As there are far more elements to the tax reform than covered here, dealers may consider familiarizing themselves with the finer details of the changes. Looping in your trusted advisor and CPA is strongly recommended to ensure you are prepared for the oncoming effects – both favorable and complex – to your financial posture.
Adam M. Neporadny, CPA | Senior Manager, DHG Dealerships
phone: 205.212.5317 | firstname.lastname@example.org