Under the tax reform rules passed in 2017, the deduction for net business interest expense was generally limited to 30% of a dealership’s adjusted taxable income plus 100% of floor plan financing interest expense. Business interest expense that exceeds this limitation is disallowed and carried forward.
Floor plan financing interest expense remained fully deductible under tax reform. But it came at a cost.
Dealerships that take the floor plan financing interest exclusion in computing their limit can’t claim 100% bonus depreciation for their fixed asset additions. Based on a literal reading of the tax law, some dealerships had been concerned that having even $1 of floor plan financing interest would prevent them from ever claiming bonus depreciation again.
Proposed IRS regulations address bonus depreciation
A dealership is eligible for bonus depreciation as long as it would be able to deduct its business interest expense without the floor plan financing interest exclusion.The IRS recently released proposed regulations under Section 168(k) (REG-106808-19) has addressed some dealer concerns:
- The prohibition on bonus depreciation applies only to assets placed in service during a year when the dealership needs to take the floor plan financing interest exclusion into account to avoid the interest limitation. The prohibition applies on an annual basis. So if a dealership uses the floor plan exclusion in one year, it does not affect the use of bonus depreciation in future years.
The proposed regulations are not effective until finalized, but taxpayers can choose to apply them now.
Some CPA firms and industry groups, including CLA, urged the IRS to allow taxpayers to elect not to take the floor plan interest exclusion into account, so that the dealership could claim bonus depreciation in any tax year. The IRS did not adopt this recommendation in the proposed regulations, but the proposed regulations are a step in the right direction.
Here is an example that illustrates how these regulations work
DealerCo is an S corporation car dealership with more than $25 million in average sales. DealerCo generates $1.3 million in adjusted taxable income, which includes $40,000 of business interest income and $400,000 of business interest (all of which is floor plan financing interest). DealerCo’s net business interest ($400,000 business interest expense – $40,000 business interest income = net business interest expense) is less than 30% of its adjusted taxable income plus its business interest income ($1.3 million x 30% = $390,000, which is greater than its $360,000 net business interest expense).
Accordingly, DealerCo is able to deduct its business interest in full without the special addback for floor plan financing interest. Thus, since floor plan financing interest is not considered to be “taken into account” in computing the limit, DealerCo can claim bonus depreciation with respect to any eligible assets placed in service during the year.
Let’s look at a variation of that example
Same facts as above except that DealerCo has $500 of business interest expense. In this case, DealerCo’s net business interest expense exceeds 30% of its adjusted taxable income ($500,000 interest expense – $40,000 interest income = $460,000 net business expense > $430,000 limit). DealerCo is able to deduct the interest in full because the limit it increased for DealerCo’s floor plan financing interest ($1.3 million adjusted taxable income x 30% = $390,000 + $500,000 floor plan financing interest = $930,000, which is greater than $460,000 in net business interest expense).
If a dealer uses the floor plan interest limit in one year, it will not have an effect on its ability to claim bonus depreciation in a future year. This provision in the regulations is different from what the IRS had indicated in prior communications.
Since DealerCo used the floor plan financing exclusion, it is prohibited from claiming bonus depreciation with respect to assets placed in service during the year. The proposed regulations prevent DealerCo from electing not to use the floor plan financing interest exclusion from the computation and therefore claim bonus depreciation. DealerCo may claim bonus depreciation with respect to assets placed in service in a later year if it does not take the floor plan financing interest into account in computing the limit in the later year.
How we can help
If you have already filed your 2018 tax return and did not claim bonus depreciation because you had floor plan financing interest, you should work with your CPA to consider whether you can claim bonus depreciation on an amended return. The opportunity is available only if you had enough adjusted taxable income and business interest income to deduct the business interest expense without including floor plan financing interest in the limitation calculation. An amended return can provide a cash refund of taxes paid during the year. CLA’s dealership professionals are here for you. Contact us for help.
John Werlhof is a principal at CliftonLarsonAllen’s Sacramento office. He can be reached at 916-218-7128. Dave Wiggins is a principal in CLA’s St. Louis office. He can be reached at 314-925-4316.