Impact of Declining Dealership Profits on Tax Obligations

Will lower profits result in reduced tax liabilities for the automotive dealership industry?

The answer is not straightforward. The automotive dealership industry is experiencing a challenging period, with profits declining in recent years.

Declining Profits and Rising Costs

The 2024 financial results for dealerships reveal a concerning trend. Overall profits have decreased, driven by several key factors:

1. Increased Personnel Expenses: Dealerships are facing higher costs related to employee salaries, benefits and other personnel-related expenses. This increase in overhead can significantly impact the bottom line.
2. Reduced Gross Profits on Vehicles: The gross profit margins on vehicle sales have declined. This reduction can be attributed to various factors, including increased competition, changes in consumer preferences and economic conditions.
3. Higher Inventory Costs: The cost of maintaining inventory has risen, particularly due to increased floorplan interest expenses. Floorplan financing, which allows dealerships to borrow money to purchase inventory, has become more expensive, adding to the financial strain.
4. Decreased Sales Volume: The volume of vehicles sold has dropped, further contributing to the decline in overall profits.

Taxable Income vs. Financial Statement Income

Several items can cause discrepancies between taxable income and financial statement income:

1. LIFO (Last-In, First-Out) Accounting: The use of LIFO accounting can lead to deflation and income pickup. In periods of rising prices, LIFO can reduce taxable income by valuing inventory at older, lower costs. However, in deflationary periods, it can result in higher taxable income.
2. Interest Expense Limitation: Section 163(j) limits the amount of deductible other business interest expense to 30% of adjusted taxable income. In a period of higher interest rates, dealerships may face restrictions on the amount of non-floorplan interest expense they can deduct, impacting their overall tax liability.
3. Floorplan Interest Deductibility: Floorplan interest expenses are fully deductible for auto dealers. However, dealerships may not be able to utilize bonus depreciation if total floorplan interest expense exceeds the sum of 30% of adjusted taxable income (ATI) and business interest income earned.

Strategic Considerations for Dealerships

Given the complex interplay between financial performance and tax obligations, dealerships must adopt strategic approaches to manage their tax liabilities effectively. Here are some key considerations:

1. Tax Planning: Proactive tax planning is essential to navigate the challenges posed by declining profits and rising costs. Dealerships should work closely with tax professionals to identify opportunities for tax savings and ensure compliance with evolving tax regulations.
2. Cost Management: Controlling personnel expenses and inventory costs can help mitigate the impact of declining profits. Implementing efficient cost management practices can improve the overall financial health of the dealership.
3. Revenue Diversification: Exploring new revenue streams, such as service and parts sales, can help offset the decline in vehicle sales. Diversifying revenue sources can provide a more stable financial foundation.
4. Financial Analysis: Regular financial analysis and performance monitoring are crucial. Dealerships should track key financial metrics and adjust their strategies based on changing market conditions.

Conclusion

By understanding the factors influencing taxable income and adopting proactive measures, dealerships can navigate this difficult period and position themselves for future success.

For more information related to this topic, please contact a member of Schneider Downs’ Automotive industry group tax practice.

About Schneider Downs Automotive Industry Group

The Schneider Downs Automotive industry group serves dealers of all sizes, from single-point locations to mega-dealerships. Our members cross departments and meet regularly to ensure efficiency in the services provided to our clients and discuss issues, regulations and trends affecting the automotive industry.  

To learn more, visit our Automotive Industry Group page.