Most of you have already closed the books for 2011 (at any rate I hope you have), and now have a reasonable picture of your profit, tax and cash flow positions resulting from that year. You have also had a chance to compare the results against your budget and cash flow projections. Hopefully, you like what you see.
I translate “like what you see” to mean you hit your profit goals or at least show reasonable profits for your efforts and management skills. Taking this yearly adventure one step further, you will next ask what the tax cost will be on those profits. Assuming you purchased rental fleet assets some time in 2011, I would expect you would use the equipment depreciation to eliminate any taxable income.
Let’s assume the equipment depreciation eliminates the taxable income. Let’s also assume you employed the 100 percent bonus depreciation that was still available in 2011 (it may be available again in 2012, but we don’t know yet), meaning the assets purchased now have a zero tax basis and therefore 100 percent taxable upon sale at some time in the future. In fact, if you used Bonus Depreciation the last couple of years, I suspect a good portion of your fleet has zero basis and is 100 percent taxable upon sale.
Up until this point, the fact that Bonus Depreciation created this 100 percent taxable situation was not a problem because you had the option to duplicate the 100 percent bonus every year through 2011, which in most cases would have eliminated the taxable income related to the sale of used rental units through 2011.
In summary, Bonus Depreciation provided a benefit to dealers with rental assets, and as long as you purchased enough replacement property the negative aspects of the program never came to light. Going forward, however, this situation will change and could trap unwary dealers with a big unexpected tax bill.
There are two issues that need to be planned for 2012 and beyond. First you will have higher tax gains on the used rental units you sell (zero tax basis) and second; your depreciation deductions will be lower. Net result, a higher than expected taxable income you need to deal with. Add in an expected increase in business activity and the tax risk goes even higher.
This tax risk presents a serious problem due to the fact if you used Bonus you have not had a tax bill for a number of years, and have used the cash you would have paid Uncle Sam for other business purposes. But since Bonus only provided a deferral of the tax payments, Uncle Sam will make up his shortfall when you sell the unit. Rental units are taxed as ordinary income because you used Bonus to offset ordinary income. The problem shows up in the size of the tax bill compared to the book income. Assuming you turn your rental fleet 20 percent a year, it is possible to see 200-300 percent increases in your tax bill starting in 2012.
To make matters worse, the timing of payments has to be considered. If you paid zero tax for 2011 you probably have zero taxes paid into the IRS for your potential 2012 liability. So next March or April you file your 2012 return and somehow come up with the tax balance due and avoid underpayment penalties since you had zero taxes due the previous year (check with your tax people about this). Feel a little better? Well don’t because the real problem is about to surface: the estimated tax payments for 2013 based on the 2012 payments. Now pay attention because this looks to me like you made a major payment in March or April and you have to pay a quarter of this amount over the next four quarters. Does this turn out to be a payment over a 12-month period of 200 percent of the already excessive 2012 tax bill? Yes it is!
Dealers with large rental fleets that used Bonus Depreciation could really experience a major cash flow issue in 2012 -13 that needs to be reviewed and planned for, and you better have a good tax person familiar with these issues helping you out with this. If you need a recommendation for a person I know is familiar with the issues let me know.
One way dealers are mitigating this “zero basis” issue is using like-kind exchange, and some of you may be using this tax application to further defer the gain on the sale of used rental units. But if you have not embraced this concept so far and you expect you will have the tax problem described, finding out about LKE as soon as possible in 2012 is in the cards for you. If the need is there and you plan to replace rental units each year for the near future, LKE could go a long way to mitigating the 2012-13 tax bills by deferring them further into the future. I suggest you contact Ron Hodgemen at WTP Advisors to learn more about LKE and how it may work for you. Ron’s phone number is 513-600-3532 and he is an industry expert. Plus, I know from personal experience that WTP offers a very cost-effective LKE program for dealers.
I titled this article “Double Trouble” with my “Double” being higher tax basis and lower depreciation deductions. I think after going through this exercise we can add improved business operations and cash requirements in 2012 and 2013.
You know I am always harping about budgets and cash flow projections, and this year you must complete them taking into account the sale of used rental units and any related tax impact. In short, you have to do a close for 2012 today, and as I write this 2012 is still a few days off.
Garry Bartecki is a CPA MBA with GB Financial Services LLC. You may contact him by e-mailing firstname.lastname@example.org.