Tax Breaks for Your Dealership in 2018 - How Can You Benefit?
The Tax Cuts and Jobs Act (TCJA), signed into law in December 2017, contains many provisions benefiting auto dealerships, including a lower, flat corporate rate and a valuable 20% deduction for those structured as pass-through entities. Let’s look at some of its ins and outs and which benefits apply to your dealership.
Lower, flat corporate rate for C corporations
The TCJA introduced deep cuts to corporate taxes by providing a permanent flat 21% tax rate for C corporations, effective as of Jan. 1, 2018. Prior to the new tax law, C corporations paid tax at graduated rates starting at 15% and peaking at 35%. The reduced flat tax rate will benefit most businesses that are structured as C corporations and prompt owners to reassess the dreaded double tax on dividends.
Fiscal year corporations: If your C Corporation has a non-calendar year (beginning in 2017 and ending in 2018), you will pay a blended rate for the 2017-2018 tax year. In other words, some of your income will be taxed the old (higher) tax rates and some at the new lower (21%) rate. Under this scenario, it makes sense to maximize deductions now as they are of greater value than in future years when tax rates will be less.
C corporation vs. pass-through entities: In some cases, the C Corporation structure may provide similar tax rate advantages as the pass-through entity structure. For example, the C Corporation might be a good option for a business not eligible for the new pass-through deduction (discussed below), or if your goal is to retain earnings in the company.
New 20% deduction for pass-through income
To help level the playing field — temporarily — Congress created a new qualified business income (QBI) deduction for pass-through entities. S corporations, partnerships, sole proprietorships and, generally, limited liability companies (LLCs) are examples of pass-through entities. For tax years 2018 through 2025, noncorporate business owners can generally deduct up to 20% of QBI, subject to some limits and restrictions. Individuals, estates and trusts that own interests in pass-through business entities will generally qualify.
With the individual rate cuts and this new deduction, the TCJA effectively lowers the top tax rate for pass-through entities by a full 10 percentage points — from 39.6% before tax reform to 29.6% now.
What is QBI?: QBI is generally defined as the net amount of income, gain, deductions and losses generated by a business, excluding investment income such as capital gains, dividends and interest. It also doesn’t include reasonable compensation paid to an owner for services rendered to the business or any guaranteed payments to a partner / member.
Limitations you should be aware of
Your deduction may be reduced or eliminated if it exceeds the greater of:
• 50% of W-2 wages paid by the dealership, or
• The sum of 25% of W-2 wages paid by the dealership plus 2.5% of the unadjusted basis of all qualified business property, immediately after acquisitions.
Qualified business property is tangible, depreciable property 1) that’s held or available for use by your dealership at the close of the tax year, 2) that’s used at any point during the taxable year in the production of QBI, and 3) for which the depreciable period hasn’t ended before the close of the taxable year. So many of your business assets (i.e. equipment, furniture and buildings) may be qualified property. The second limitation is especially helpful for real estate entities that do not pay W2 wages.
The wages and capital limit is phased in starting at an income threshold of $157,500 for single filers and $315,000 for married couples filing jointly. It fully applies once income reaches $207,500 for single filers or $415,000 for joint filers.
Finally, note that the QBI deduction can’t exceed your dealership’s taxable income for the year. If the net amount of your QBI is a loss, you can carry this amount forward to the following year.
Owner compensation: Consider analyzing what the appropriate amount in wages you receive from an S corporation or guaranteed payments from a partnership or LLC to maximize income that is eligible for the new 20% deduction. The more income that is left in the business, the larger the deduction.
Aggregation of trades or businesses: If you have ownership in multiple dealerships or other pass-through entities, the proposed regulations create an opportunity to group these businesses for purposes of the wages and capital limitations, discussed above. This could benefit you if your 20% deduction might otherwise be limited. Certain tests must be met before grouping is allowed.
Fiscal year pass-through entities: If your dealership has a non-calendar year (beginning in 2017 and ending in 2018), then QBI for that period is also eligible for the new 20% deduction. This is because the deduction is computed at the individual taxpayer level.
Expert advice needed
The new reduced flat tax on C corporations and the QBI deduction for dealerships structured as pass-through entities could be valuable tax breaks. As you can see, though, the details are complex and proactive planning for these items will often maximize the benefit. You should speak with your tax advisor about how your dealership might benefit from these provisions.