Tax Reform and Your Business: Automobile Dealerships (article)
Part I of a series connecting provisions of the 2017 tax bill to those affected by it
The 2017 tax bill, commonly known as the Tax Cuts and Jobs Act (TCJA), contained a dizzying number of changes to the Tax Code. These changes affect every kind of taxpayer, with some taxpayers experiencing more changes than others. Automobile dealerships (auto dealers) are among those who were impacted significantly by the TCJA. While auto dealers survived a scare that last-in, first-out (LIFO) inventory accounting might not be preserved after the TCJA, other important changes involving "floor plan financing" interest will change the tax strategy for auto dealers immediately.
Business Interest Expense Limitation
One of the largest changes in the TCJA was a new limit on deductions for business interest expense, a tax policy measure designed to partially offset the cost of other tax cuts under the TJCA. This new provision applies to any business that is a "tax shelter" and to most other businesses with average gross receipts in excess of $25 million (over the prior three-year period). For these businesses, interest expenses are deductible to the extent of interest income plus 30 percent of an amount that is essentially earnings before interest, taxes, depreciation, and amortization (EBITDA). After 2022, the 30 percent limitation will become more restrictive as it will be limited to interest income plus 30 percent of earnings before interest and taxes (EBIT). Any interest that is not deductible under this limitation is carried forward as if it were paid or accrued in the following tax year. However, auto dealers won a reprieve from this limitation in the preservation of a 100 percent deduction of floor plan financing interest.
Floor Plan Financing Interest
The exception to the 30 percent limitation on business interest allows auto dealers to deduct 100 percent of the interest expense on financing associated with the cost of acquiring motor vehicles for resale or lease, provided the debt is secured by the vehicle. For purposes of this rule, a motor vehicle is any self-propelled vehicle designed for transporting persons or property on a public street, highway, or road; a boat; or farm machinery and equipment. Off-road vehicles such as dirt bikes and ATVs are not included. As a practical matter, nearly all auto dealers incur such floor plan financing interest.
The Senate's version of the TCJA proposed limiting the deduction for floor plan financing interest to the same 30 percent amount that other types of interest are subject, but this change was not adopted in the final bill. Auto dealers who are eligible for this preferential treatment on floor plan interest must claim it (it is not elective or optional). This leads to an unexpected trade-off. Any business that deducts floor plan financing interest cannot claim bonus depreciation on any property acquired by that trade or business.
As a result, virtually no auto dealers will be able to take advantage of the expanded bonus depreciation provisions of the TCJA. The expanded bonus depreciation provisions allow for "full expensing" in many instances. Full expensing is the commonly used term for the ability of a business to deduct 100 percent of the cost of qualifying assets (which now include both new and used property) in the year of purchase. This provision accelerates cost recovery over the regular depreciation rules, which generally prescribe deductions over five or more years. The expanded bonus depreciation deduction is fully applicable until 2023. For years after 2022, the expanded deduction will be phased out gradually until it is eliminated after 2027. Unfortunately for auto dealers with floor plan financing, these bonus depreciation rules are unavailable because of the requirement to deduct 100 percent of their floor plan financing interest (which may be a much smaller benefit than bonus depreciation).
The TCJA preserved the ability of auto dealers to deduct floor plan financing interest, expenditures that are prevalent in the industry. However, this did not come without a cost — these dealerships will not be able to claim bonus depreciation on any fixed asset expenditures. The interplay of these provisions highlight the trade-offs that come when Congress enacts major tax legislation, and is likely to affect tax planning for auto dealers anticipating major capital expenditures. For more information on these deductions and how your business can best take advantage of the changes within the TCJA, please contact your CBIZ MHM tax professional.
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