Navigating Tax Regulations: An Accounting Guide for Car Dealerships

June 20, 2023

The accounting office isn’t always the first department a dealership looks to optimize profit, but it should be. An efficient reconciliation process can illuminate areas where a dealership might save money.

While the new tax law was passed, it’s unclear how it will affect dealer operations. This article will provide some guidance.

Deductions

Deductions are a great way to reduce your taxable income. When you add up deductions, you subtract them from your gross income and have a lower tax liability.

For example, a dealership may charge buyers a documentation fee, or “doc fee,” to cover the cost of the paperwork involved in selling a vehicle. The average doc fee in New York is $75 per sale.

In addition, dealerships should consider bundling items that are normally not itemized, such as charitable contributions, investment interest expenses, or significant medical expenses, in one year to increase the total amount of itemized deductions. This strategy could especially benefit a dealer subject to the new $24,000 standard deduction for individuals in 2018.

Finally, dealerships should take advantage of Section 179, allowing dealers to expense 100 percent of qualifying fixed assets in the year they are in service. Although the new law eliminates bonus depreciation on floor plan financing indebtedness, dealerships using this depreciation method should monitor future IRS guidance to see if it is reinstated for dealership property.

Dealerships with a substantial used vehicle inventory should consider adopting last-in, first-out (LIFO) if they don’t already use it. LIFO decreases taxable income by the inflation rate and may be a better option than vehicle write-downs, which only reduce the carrying cost of the old vehicles in inventory.

Interest Expense

Car dealers deal with many transaction complexities, including accurate dealer accounting, state and local tax compliance, and adherence to manufacturer financial covenants. To maximize profits and operational efficiency, a dealership must reconcile daily bank statements and perform a comprehensive chart of accounts review.

Dealerships need to set up separate line items in their chart of accounts for each of the various services they offer, like service contracts; floorplan financing; credit agreements with borrowers and lenders; vehicle leases; finance contracts; warranty products; and so forth. This allows them to track and monitor these services and their associated costs.

The income statement includes a line item called “interest expense,” which represents the cost of money that a business pays as part of a debt-financing arrangement. This is considered a non-operating expense and can be calculated as the interest rate times the principal amount of the loan or debt instrument.

Interest expense is deducted from EBIT (Earnings Before Interest and Taxes) to arrive at net income. This reduces taxes owed and is referred to as the interest tax shield.

Sometimes interest expense is listed as a separate line item on the income statement, and other times it’s combined with interest income, which is the income a company receives from sources such as its savings bank account. In such cases, it’s commonly called “Interest Expense – net.” Regardless of how the item is named, its calculation is straightforward: subtract the interest expenses from the earnings before taxes (EBT) line item on the income statement.

Other Business Expenses

Many car dealerships incur expenses beyond those related to the sales of automobiles. These may include utilities, advertising, personal commissions, and insurance. Accounting methods and procedures can manipulate some of these expense items.

For example, a car dealer may use LIFO inventory accounting, a time-honored method used by industries reliant on large inventories. This allows the business to use the last in, first out approach to its cost of goods sold deductions. However, this can result in higher taxable income during price increases and lower taxable income when prices drop.

Another example involves the treatment of depreciation expense. Dealerships can accelerate depreciation on assets that are expected to be subject to future higher tax rates. This technique can help a dealership lower its overall income tax expense, and it is a popular strategy among dealers that use Section 179 depreciation.

Another way to control income taxes is to properly record and report all accounting transactions. A thorough review of the trial balance at month-end could help a dealership identify errors, such as an item being expensed instead of capitalized and amortized. It also can help the company see areas where a more efficient reconciliation process is needed to avoid misstatements that could lead to inaccurate reports and tax consequences.

Sales Tax

Sales tax is a local tax charged by state and city governments on eligible purchases to generate revenue for essential services. Sales taxes encourage economic growth by ensuring that everyone who participates in the economy contributes to the community’s budget for these vital services.

As with other forms of government taxation, establishing a broad tax base is crucial for sales tax proposals to succeed. Specifically, the more items are included in the tax base, the lower the rate can be. However, allowing specific exemptions creates a slippery political slope where loopholes granted to one group fuel demand from other groups for similarly beneficial tax breaks.

Car dealerships are subject to a variety of state-specific rules when it comes to sales tax. For example, some state tax cars based on the full purchase price before manufacturer cash rebates or dealer incentives are applied. Other states only tax the new car purchase amount if a trade-in vehicle is involved. Then the taxable total is derived by subtracting the trade-in value from the new car purchase price.

In either case, dealers must keep impeccable records of all car sales tax collected and remitted because the IRS requires accurate sales tax reporting. Using an accounting software program like FreshBooks makes the job easier by automatically logging each invoice payment and recording the relevant taxes owed.

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