As I mentioned in a few prior columns, I was planning both a webinar and CFO conference for equipment dealer CFO’s and other interested parties. The webinar addressed the tax changes expected for 2013 that would impact dealer tax bills. The CFO conference primarily focused on rental from an accounting, tax and financing perspective. Included in the CFO program was a two hour session on dealer and rental tax issues. Both programs were well attended and well received and I would like to summarize some of the items discussed that may be of interest to a typical material handling dealer.
As I am sure you have heard individual rates will increase as follows:
- Individual rates from 35% to 39.5%.
- Capital gains from 15% to 20%.
- Dividends from 15% to ordinary rates.
- Estate tax exemption back to $1 million from $5 million.
On the business side the changes are:
- Bonus depreciation gone after 2012 (there is talk of extending this).
- Section 179 down to $25,000 and thus meaningless.
- Rate increase of .9% to 2.35% for incomes above $200,000 single/$250,000 married.
- Combined employee/employer rate for such wages to 3.8%.
Medicare tax on unearned income
- Beginning in 2013 a 3.8% tax on lesser of unearned income, or any excess of modified AGI for the tax year over threshold amounts noted above.
- Net investment income INCLUDES RENTS AND THE NET GAIN ATTRIBUTABLE TO THE DISPOSITION OF PROPERTY RELATED TO THE PASSIVE INCOME.
Believe it or not, this section applies to your dealer rental activity if the tax structure is a flow-through entity (Sub-S, LLC as partnership, trust, etc.) If the dealer entity is a C-corp you are out of the woods. If you are picking up dealer tax results on your personal return the gains from your rental activities will be subject to this tax, including any tax gain on the sale of rental units. So, if you used Bonus Depreciation for tax purposes you have at least a portion of your rental fleet with a zero tax basis, which when sold will be 100% taxable and add to your net investment income. Since most material handling dealers have significant rental fleets I would conclude you have an issue starting in 2013. I know you are thinking you are in the material handling business and this can’t apply to you. Sorry to say, it does. There are some exceptions to the passive activity rules and they are:
Rental activities can be considered non-rental if the average period of customer use is limited to seven days or less, or less than 30 days. The formula to make this calculation is aggregate number of days in all periods of customer use in the tax year divided by the number of periods of customer use. For example, if they rented for 100 days through 3 rental transactions the average is 33 days. The rental activity is insubstantial in relation to the trade or business activity. There are no benchmarks for determination but an 80/20 test may be a place to start.
This one new tax change is one we spent some time on in both the webinar and CFO conference. As with most IRS mandates it is best to have your policy and plan documented as opposed to letting the IRS figure it out for you. And just so you know, a dealer at the conference said an agent conducting a recent tax audit asked for a big sample of rental contracts to see how many were over 30-days in length.
As if the passive income/loss issue isn’t enough, the new fixed asset Capitalization Rules will add even more complexity to your rental fleet operations. These are in effect for 2012 and again require a written capitalization policy and a demonstration of compliance to avoid having the IRS make the calculation for you. What will this do for you….it will increase the cost of the fleet because of additional front end cost and capitalized repair and maintenance costs, and as a result increase your taxable income. And, let’s not forget it will certainly mess with your dollar utilization stats. These regulations are similar to the 263A rules you apply to your inventory. As you may recall the 263A rules require that costs incurred prior to the decision of making purchases be added to the purchase cost. With these new regs you have the same situation, only now it applies to fixed assets which include your rental fleets.
There are de minimus rules that apply if you have a written policy and you apply the policy for book purposes. The aggregate deduction may not exceed the greater of .1% of gross receipts or 2% of book depreciation. There is however, a fly in the ointment and that is you need to have audited financial statements to use these de minimus rules. At a minimum you now need a capitalization policy spelling out how you record and expense repair and maintenance items and how you determine if the useful life of a fixed asset is extended by a repair or restoration project. So your tax rates are increasing, a new tax exposure could add significantly to your tax burden and you will increase book income because you have to capitalize acquisition and repair costs.
Now wasn’t that fun? As I have mentioned in the past couple of months, if your tax person does not have extensive experience in the dealer/rental industry you are either in for a big fee increase, a big tax increase or a big exposure if you do nothing. Steve Pierson (my right hand tax expert) and I are putting together some templates to deal with the decisions you need to make regarding these complex issues. My suggestion would be to cover your butt on these issues without spending a fortune to do it. Who knows, the election results may have an impact on these new regs. If we need to chat you can get hold of me through MHW or by phone at 708 347 9109. Steve Pierson can be reached at 630 954 1400. Both of us will be in the MHW booth at ProMat.
Garry Bartecki is a CPA MBA with GB Financial Services LLC. E-mail firstname.lastname@example.org to contact Garry.