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Tax Reform Update for Buy Here – Pay Here Dealers: What Has Changed and What Comes Next?

Posted 7:05 PM by

Note: This article originally appeared in The Showroom.

The Tax Cuts and Jobs Act (TCJA) passed by Congress in December 2017 may seem like old news, but many buy here – pay here (BHPH) operators are just now feeling the impact of the changes. So, what looked different on your tax return this year, and what can you do to prepare for next year? The following is a summary of key provisions for BHPH operators and some practical takeaways:

Individual Tax Return Changes

  • Personal Exemptions: Under the new tax law, personal exemptions are eliminated beginning in 2018.
  • Standard Deduction: The standard deduction increased from $12,700 to $24,000 for married filing jointly filers and from $6,350 to $12,000 for single filers under the new tax law.
  • Itemized Deduction Limitation: Under the previous law, itemized deductions were limited once a taxpayer’s adjusted gross income (AGI) reached $313,800 for married filing jointly filers or $261,500 for single filers. The TCJA suspends these limitations.
  • Miscellaneous Itemized Deductions: The law suspends all miscellaneous itemized deductions subject to the 2% floor. Examples of miscellaneous itemized deductions include tax preparation fees, unreimbursed employee expenses, and investment expenses.
  • State and Local Tax Deduction: The new tax law allows individuals to elect to deduct sales tax, income tax, or property taxes up to $10,000.
  • New Individual Tax Brackets: The new tax law retains seven tax brackets but lowers the tax rate in the majority of brackets, including lowering the maximum tax rate from 39.6% to 37%.

BHPH operators’ application: The above provisions are being included as they relate to the overall tax calculation at the individual level. While personal exemptions are being eliminated, the standard deduction is being doubled. However, most BHPH operators will likely itemize deductions instead of using the standard deduction. Itemized deductions are no longer subject to an overall separate limitation based on AGI, but itemized deductions for state and local tax are now limited to $10,000. Previously, individuals would receive a deduction for the state taxes paid. It is assumed that the BHPH operators have state and local tax of at least $10,000 from other items (wages, property taxes, etc.); consequently, the deduction is virtually eliminated. Because of this, dealers conducting business in certain states might consider paying corporate state level taxes instead of paying taxes as a pass-through entity. Note that state and local taxes assessed at the company level are still 100% deductible to the company.

Pass-Through Taxation

  • General Rule: Under the new tax law, owners are allowed to deduct 20% of their qualified business income from pass-through entities on their individual income tax return. Under this provision, qualified business income is defined as domestic income from a pass-through entity but does not include investment income (e.g., dividends, capital gains, and investment interest), reasonable compensation, or guaranteed payments.

In general, the pass-through deduction is further limited to the greater of:

  • 50% of the individual’s share of W-2 wages paid by the pass-through entity for its workforce, or
  • the sum of 25% of the individual’s share of W-2 wages paid by the pass-through entity plus 2.5% of the unadjusted basis of all qualified property.

However, an individual taxpayer would be exempt from this W-2 limitation if their taxable income does not exceed $315,000 for married filing jointly filers or $157,500 for single filers. This deduction is a “below the line” deduction, or a subtraction from AGI. This deduction is limited to 20% of total taxable income (excluding capital gains).

BHPH operators’ application: Most BHPH operators own pass-through entities and will have qualified business income that is eligible for the 20% deduction. Operators who own multi-entity pass-through structures including a Related Finance Company will need to be cognizant of the wage factor limitation as the pass-through deduction is calculated separately for each entity. BHPH operators may consider making an aggregation election for the factors of qualified business income between entities, if applicable, on their personal returns.

Inventory Accounting

  • Businesses with average gross receipts for the preceding three tax years of $25 million or less can elect to change their method of accounting for inventory. This change would allow expensing of inventory and would generate a significant deduction in the year of change.
  • As part of the requirements for this election, the taxpayer must use the same accounting method on its applicable financial statements (AFS). AFS can generally be thought of as being audited financial statements.

BHPH operators’ application: Most BHPH operators that do not have audited financial statements and are under the $25 million gross receipts test should consider electing to expense their inventory to receive a significant deduction in the year of change.

About the Author
Jeremy Lill is a manager in Katz, Sapper & Miller’s Business Advisory Group. Working with clients in a variety of industries, Jeremy helps them develop strategies to minimize tax liabilities and solve their complex business challenges.

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