With dealer margins coming back to earth after the pandemic, the industry will need to pay closer attention to expenses to maintain a strong bottom line. For most dealerships, the fastest-growing expense over the past couple of years has been interest expense. Lots are full and higher interest rates appear to be here to stay. Managing inventory and negotiating floorplan rates may not be enough to curtail these rising costs. Well-capitalized dealerships can avoid flooring their used inventory or move excess reserves into an account with the lender, which offsets their floorplan and reduces interest expense. This strategy is effective, but only if there is excess cash available in the dealership. Dealers may be tempted to loan their personal funds to the dealership to accomplish this reduction in costs. On the surface, this makes sense; CDs and money market accounts are not paying rates as high as floorplan rates, so why not move the money over to lower costs? To understand why that might have unintended consequences, we must look at a tax law that has been on the books since 2018.
The Tax Cuts and Jobs Act imposed a limitation on the deduction for business interest expense. Larger businesses ($30 million or more in average gross receipts) can deduct business interest if it does not exceed 30% of their adjusted taxable income. The full impact of the law was not felt until 2022, when dealers could no longer add back depreciation and amortization expense to keep their adjusted taxable income high. An exception was made for dealers to deduct floorplan interest even if their income could not support it, but many dealers did not need that exception because income was high and interest expense was low. They could even benefit from bonus depreciation if their floorplan interest was not limited. This was a real win for dealers.
Fast forward to 2024, let’s consider how this impacts the dealer who loans their personal funds to the company to offset rising floorplan costs. Unless the dealership income can support the deduction (as described above), they may be swapping a deductible expense for a disallowed expense. The exception for dealers only applies to floorplan interest expense, interest on loans from owners does not receive the same treatment. Furthermore, the IRS requires related party loans pay or impute interest at no less than published Applicable Federal Rates (AFR) (mid-term annual AFR for June 2024 is 4.66%), so the dealer may be personally paying tax on the interest income from their loan to the company even though they are not allowed to deduct the interest expense through their business.
This law impacts more than just the loans dealers make to their dealerships. A dealer may finance the purchase of equipment or facility upgrades and be surprised to learn the interest expense from the loan is disallowed, and they’re not eligible to take bonus depreciation on the equipment or upgrades. The limitation also carries to commonly controlled entities, so even interest expense on real estate held in a related entity could be disallowed.
The complexity and nuances of this law are too much to dive into in one article but know there are tax planning opportunities to help reduce the negative impacts of the business interest expense limitation. Make sure you are working with a tax professional who is familiar with the law and how it affects dealers.
Steve Williams works with individuals and businesses out of Tetrick & Bartlett’s Fairmont office to meet their tax and consulting needs and is in charge of the employee benefit plan audit practice for the firm. Tetrick & Bartlett PLLC currently serves over 50 dealers in West Virginia, Virginia, Ohio and Pennsylvania, and is a member of the AutoCPA Group, a nationwide organization of CPA firms specializing in services to automobile dealers.
