The automotive retail industry is no stranger to oversight and regulations by both state and federal authorities. In addition, because dealerships are major producers of both financing and insurance products, state and federal insurance and lending, authorities also supervise their activities closely. Acknowledged as the litmus of the economy, the Department of Commerce demands reports to monitor the swings in the economy. And then there is the Department of Transportation, which is famous for recalls, and the Occupational Safety and Health Administration is involved in the safety aspects of automobiles and dealership facilities. Given all of these overseers, the retail automobile industry is one of the most monitored and regulated industries. Consequently, when something as impactful as the Tax Cuts and Jobs Act of 2017 (TCJA) is passed, dealerships face far-reaching implications.
With all the commentary out there on how the TCJA affects the business, we thought it was important to share some additional perspectives. We reached out to a national dealership firm, Crowe LLP, to get tax accounting insights on how the TCJA affects dealers and dealerships.
Let’s walk through some questions and answers with Steven Janssen, dealer CPA with Crowe, and Dr. Merlot, one of The Rawls Group’s renowned associates.
From your perspective, what is the Tax Cuts and Jobs Act of 2017?
Steve the CPA: The TCJA is the most complex and comprehensive piece of tax legislation in more than 30 years. It was signed into law in late 2017 and has significant changes to taxation for both businesses and individuals. The Treasury and IRS recently have issued guidance on several significant provisions of the TCJA that add clarification in several areas, but much uncertainty still remains to be addressed. Most provisions went into effect Jan. 1, 2018.
Loyd (Succession Planner): The good news is that this law offers some overdue tax relief for both active and passive owners of dealerships and real estate entities and provides more gift and estate tax relief. However, as many of you have learned, this does complicate the reinsurance environment.
Dr. Merlot, Loyd’s Straight-Talking Associate: Regardless of the promotion, we are never better off after-tax legislation. Give it time, you’ll hate it. The follow-up political noise should serve notice that any perceived benefit is short-lived
Will individual consumers’ tax savings and increased tax-home pay result in higher revenues for dealerships?
Steve the CPA: Individual tax law changes likely will result in additional after-tax cash flow for most individuals. There continue to be seven tax brackets, but several of the rates (including the highest individual tax rate) were reduced and the brackets expanded, meaning most individuals will have more income taxed at lower rates before reaching the new lower top tax bracket. Other key elements include a higher standard deduction, which almost doubled for both single and married taxpayers, and an increased child tax credit amount that was doubled to $2,000 per child with higher income limitations, making the credit available to more taxpayers.
The reduction in federal income tax withholding due to the tax rate changes resulted in changes to the income tax withholding tables in 2018, which generally means lower amounts of income taxes withheld from employees’ paychecks. In addition, numerous U.S. corporations have used portions of their corporate tax savings to pay employee bonuses and raise wages/salaries. This increased cash flow from maximized tax advantages and increased pay has potential impacts on consumer spending that may include increased demand for new or used vehicles as well as car buyers more willing to purchase extended warranties and other finance and insurance products.
Loyd (Succession Planner): A more robust economy should impact the productivity of a dealership and commensurately make a dealership more valuable to owners and prospective buyers.
Dr. Merlot, Loyd’s Straight-Talking Associate: Unfortunately, this tax law does not make a dealership easier to operate in the hyper-competitive, oversupply market. As current sales figures reflect; the additional consumer spending is not favorably impacting the profitability of a dealership. The only sure pathway to build value through the next generation is “Rambo Marketing” – put a knife between your teeth, a bandana to catch the sweat and fight for every dollar of gross while assuming both the manufacturers and consumers are out to screw you.
Will TCJA tax savings result in dealership growth and/or higher personal wealth?
Steve the CPA: The TCJA includes several tax-saving provisions that might be very beneficial to most dealers:
Section 199A pass-through deduction. Most dealers will benefit from a new 20 percent deduction on qualified business income from pass-through entities (such as partnerships and S corporations). This new 20 percent deduction coupled with the new lower top tax rate of 37 percent will result in many dealers paying a top effective rate of 29.6 percent on pass-through income from a dealership in 2018, compared to the prior top tax rate of 39.6 percent in 2017. This is a rate reduction of 10 percent on dealership income.
For dealers with separate real estate companies that lease the dealership property to the operating dealership company, recently issued proposed regulations also provide that the rental income from the related rental real estate company also likely will be considered qualified business income for purposes of calculating the 20 percent deduction, if the real estate company and the related dealership are under common control (at least 50 percent shared ownership).
This new 20 percent pass-through deduction combined with the lower 37 percent top individual tax rates means many dealers will see a 25 percent reduction in the tax liability on their 2018 pass-through income from their dealerships and related rental real estate companies if compared to the same taxable income in 2017.
Bonus depreciation. The TCJA allows 100 percent bonus depreciation on new and used assets for most businesses for years 2018 through 2022. Beginning in 2023, the bonus depreciation is reduced by 20 percent until it is completely phased out in 2027. Language in the TCJA disallows bonus depreciation on property used primarily in a business that deducts floor plan interest. However, the language regarding this restriction is ambiguous as to whether this restriction absolutely prevents dealerships with floor plan financing interest or related rental real estate entities from enjoying the benefits of the new 100 percent bonus depreciation. Additional guidance from Treasury is needed to clarify this topic. If future guidance is favorable and allows dealers and their related rental real estate companies to benefit from the new 100 percent bonus depreciation, this will further increase their tax savings.
Section 179 expensing. The TCJA doubled the Section 179 allowance from $500,000 to $1M (with indexing for inflation).
Loyd (Succession Planner): No doubt, a prolonged increase in the net profits of a dealership will make them more valuable both as an income-producing entity and as a marketable asset. This value will serve as encouragement for successors, be that a key manager or family members, to put in the work that will prepare them for the challenges associated with leadership and ownership. However, if simple supply and demand economics applies, the pent-up demand for goods and services will drive up the value of your dealerships and real estate through inflation, which will increase the estate and gift tax exposure on transfers to family members.
Dr. Merlot, Loyd’s Straight-Talking Associate: Here’s the hard-core reality; a smaller proportion of next-generation successors are willing to put in the time and effort required to be an approved successor by the franchises. Therefore, the percentage of dealers “Seeking Succession” will not increase. Furthermore, behind the hoopla of this tax cut, government spending has not gone down while according to the expert above, tax collection will be going down. Even I can interpret this as bad karma. There is going to be pay-back, and you know who is going to be paying more taxes. Therefore, I would be looking at any of these tax savings like LIFO, stash the cash so you are prepared for the recall.
Should dealers look for opportunities to grow and expand?
Steve the CPA: Many dealers will have more cash flow and will be asking how they should deploy their increased after-tax profits. The answer depends on the unique circumstances of each dealer. Prudence might suggest that additional cash flow be directed at any uncomfortable debt. Then, it might be wise to consider expanding service capacity to capture a greater percentage of recurring income. Of course, dealers also might consider facility updates based on pressure from manufacturers. And risk-takers might want to use any added cash flow to acquire additional stores
Loyd (Succession Planner): Capital is king! Reduce debt and address those capital expenditures in service capability, facilities, and technology that will prepare your successors to deal with the challenges that are on the horizon.
Dr. Merlot, Loyd’s Straight-Talking Associate: Squirrel the cash to build personal financial independence from the business. If you feel good about your financial security everyone around you will feel better and more encouraged to make the commitment and take the risks associated with succession. The ultimate downer is for your successor to have you breathing down their neck because you are concerned that their business bravado may put you in the poor house.
How will the new law impact a dealer’s estate planning?
Steve the CPA: In addition to income tax reductions, the TCJA also provides for enhanced estate planning and wealth-transfer opportunities. The lifetime exclusion is temporarily increased from $5 million per person to $10 million per person, indexed annually for inflation. In 2018, the lifetime exclusion is $11.2 million per person, and it’s $22.4 million combined for a married couple. The expanded lifetime exclusion amount under the TCJA is set to expire at the end of 2025. Dealers should examine their old wills and estate plans and consider what updates should be made in light of today’s new tax environment.
Loyd (Succession Planner): The optimum utilization of estate and gift tax credit is both a professional talent and an art form. Call your advisors together and ask how you can utilize the credit to eliminate the threat estate taxes have to the succession of your business. This is not just dusting off your will. This is the development of a strategic estate plan that will potentially eliminate the need for expensive life insurance and serve as the foundation of your succession strategy.
Dr. Merlot, Loyd’s Straight-Talking
Associate: The $5.2MM additional estate and gift tax credits is the bunny that jumps out of the birthday cake: a total surprise. None of us in the trade saw this coming. Therefore, you should assume that in 2025 it could go away just as easily. No need to die to use it! Just call your attorney, accountant or Loyd and ask how you could leverage the $5.2MM additional credit to move $52MM of assets out of your estate. The movement of that decimal point can determine if your business survives the transfer to your successors.
When tax perspectives change, it is an opportune time for dealers to look at where they’ve been and, more important, where they are going. Making sure strategic planning is in sync with their tax position, estate planning, and wills will have an impact on their family and legacy.
(This article was co-written by Loyd H. Rawls, President/Chairman of The Rawls Group; and Steven P. Janssen, CPA, a Tax Senior Manager with Crowe, LLP, with nearly twenty years of public accounting experience (the last ten years with Crowe dedicated to servicing and advising clients across the country in the retail dealership industry.)
1 Nick Wells, Helen Zhao, and Fred Imbert, “These Companies Are Paying Bonuses With Their Tax Savings,” CNBC, Jan. 26, 2018.