The good news is that virtually every dealership will pay lower federal income taxes in 2018. This article summarizes some of the significant provisions of the new tax act as they relate to dealerships in 2018.
Individual Tax Rates – All of the tax bracket rates are lower by a few percentage points. For example, the highest tax bracket of 39.6% is now reduced to 37%.
New 20% Pass-Through Deduction – The majority of dealerships are organized as S Corporations or LLCs taxed as partnerships. These entities are considered “pass-through entities.” Pass-through entities are taxed at the dealer’s individual tax rate. Pass-through entities will receive a deduction equal to 20% of their taxable income. For example, a dealership has taxable income of $1,000,000 and is a pass-through entity. The dealer’s individual tax rate is 37%. Therefore, the dealership would receive a deduction of 20% or $200,000 and be taxed on $800,000 at a rate of 37%. This translates to a “net” tax rate of 29.6%. This compares to a rate of 39.6% in 2017. Keep in mind that dealers who are not in the highest tax bracket will pay a “net” tax lower than 29.6%.
Limitations on 20% Pass-Through Deduction – The deduction cannot exceed 50% of your W2 wages or 25% of W2 wages plus 2.5% of unadjusted basis of depreciable assets. These limitations should not apply to dealers as they pay a significant amount of wages.
C-Corporations – The tax rate is reduced to a flat 21%. Should dealers switch to a C Corporation? The answer is most will not switch due to these considerations. C Corporations are subject to double taxation. The dealership will pay federal tax at a lower rate of 21% on its taxable income. When the dealer takes a distribution of the income retained by the store, they will incur an additional tax at a dividend rate of up to 23.8%. Dealerships organized as an S Corporation or LLC will pay a maximum rate of 29.6% and will be allowed to distribute the taxable profit free from tax. Also, an S Corporation or LLC will receive capital gain treatment on the “blue sky” portion of a sale and pay a “one layer” tax at a rate of 20%. A C Corporation will pay tax at a rate of 21% on the “blue sky” and the dealer will pay a tax at 23.8% when he/she distributes the proceeds from the sale. Thus the combined maximum federal tax rate for a C Corporation will be almost 40% when the profits are distributed as dividends to the dealer. Which dealerships may consider a switch to a C Corporation? The answer is a dealership that does not contemplate a sale in the near term and plans on retaining the profits in the store.
Other Provisions:
- LIFO has been retained; there is no change.
- Floor plan interest is excluded from new limitations on interest deductions.
- State income taxes and real estate taxes will be limited to $10,000 per year.
- Itemized deductions are no longer reduced by 3% of your adjusted gross income.
- Estate tax exemptions have doubled and are now $11.2 million per individual and $22.4 million for a married couple.
- Section 179 election to expense certain depreciable assets has increased from $500,000 to $1,000,000. This will be adjusted annually for inflation.
- Entertainment expenses are no longer deductible.
There is a lot more detail in the hundreds of pages of this legislation and, clearly, this is not tax simplification. Each dealership is unique and the tax reform’s impact will be different depending on your dealership’s circumstances. Overall, the good news is that your tax bill should be lower in 2018.
If you have any questions regarding this article, please contact Paul McGovern at 800-849-6022 or at PMcGovern@DowneyCoCPA.com.
