Pub. 3 2014-2015 Issue 1

Summer 2014 25 W hen you’re buying or selling a dealership, it’s easy to miss tax problems before the sale—especially when you’re moving full-steam-ahead toward closing. And these tax icebergs (or “taxbergs”) can often, unfortunately, become deal killers. Over the last 25 years LLCs and S corporations have gained popularity among dealership owners. They offer flexibility in structuring ownership interests and generally don’t pay federal income tax, instead passing taxable income or losses through to their owners. This allows dealers to take advantage of many beneficial tax strategies (often deferrals), meaning more cash can be immediately reinvested into the dealership. Certain ways of computing revenue and deducting expenses often generate positive timing differences, which build up and reverse over time. These differences need to be managed carefully. Because the IRS doesn’t require LLCs or S corporations to report the cumulative timing differences on their tax returns, most owners have no idea if they owe a future tax liability or own a future tax asset. These taxbergs (good or bad) are usually lurking under the water and don’t become an issue until the dealership is sold or an interest is transferred. Common Taxbergs Last in, first out inventory management (LIFO). Although LIFO is recorded on most dealerships’balance sheets, its tax effect isn’t. If you’re acquiring a partial interest in an LLC (though planning exceptions are available) or S corporation with significant LIFO reserves, you’ll be the proud owner of those reserves. You’ll pay the tax on the portion you purchase, not the seller—but awareness before the sale could give you negotiating power. Be aware that the sale of a controlling interest in a storemay inadvertently create a tax event whereby the entire LIFO reserve becomes taxable at transfer. Accelerated tax depreciation. These tax methods are common, and the bonus depreciation offered these past years has made the tax savings especially rich. Over time accelerated depreciation builds up, then reverses. Used car write-downs. Some dealerships write down used car inventory on their books, an annual computation that pushes income into the next year. In many cases write-downs appear only on the tax return and are accounted for as a timing difference in the current year. Unfortunately, only the change between last year’s and this year’s write- down is flowed through the tax return; the cumulative write-down isn’t reported. This makes the tax burden especially difficult to see coming. Factory incentives. The tax treatment of advertising credits, interest credits, and other incentives may qualify as tax timing differences. Accruals. Bonuses, vacation payable, and other reserves can sneak up on you when they reverse. These common taxbergs are just the beginning, and they’re why so many sellers want to sell an interest in their entity rather than make an asset sale. Most buyers are keenly aware of the tax effects of each (most entity sales, for example, qualify for capital gains treatment) but when the buyer is computing the net tax effect to the seller, taxbergs are often missed. Understanding the true value of the taxbergs transferred to you at closing will make you a savvy buyer—and should give you more power to negotiate. Valerie Allen, CPA, leads the Southwest region’s Automotive & Dealer Services Practice at Moss Adams LLP. In addition to more than 20 years of public accounting experience, she has five years of experience in private accounting, having been the controller of a large dealership group. (505) 878-7233 | valerie.allen@mossadams.com Robert Hinton, CPA, has been in public accounting since 1988 and is the National Leader of the Automotive &Dealer Services Practice at Moss Adams LLP. In addition to tax and assurance services, he provides management, systems, operations, and profitability consulting as well as succession planning, due diligence, and witness testimony services. (253) 284-5232 | bob.hinton@mossadams.com Sid Tobiason, CPA, Moss Adams LLP, has practiced accounting since 1978. He advises clients on federal income tax, estate tax, entity structure, the purchase and sale of businesses, ownership transition, and succession planning. (858) 627-1448 | sid.tobiason@mossadams.com Taxbergs: Tax Deal Killers to Avoid When Selling Your LLC or S Corporation By Robert Hinton, Valerie Allen, and Sid Tobiason, Moss Adams LLP