An IRS decision made in late 2010 has created two new ways of treating inventory that could save a construction equipment dealership thousands of dollars in taxes.
Before then, the IRS required dealerships to include storage and handling costs in the total values of their inventories. The practice, called capitalization, increased the income on which a dealership was taxed.
In Nov. 2010, the federal government enacted Revenue Procedure 2010-44, which offers two new “safe-harbor” options to help dealerships that have $10 million or more in annual gross receipts reduce their inventory capitalization and resulting taxes.
Dealerships can elect to use neither, either, or both safe-harbor options.
Choice 1: Retail sales facility
Under this choice, a dealership may treat its entire sales facility as a “retail sales facility” and deduct all handling and storage costs incurred at the sales facility. The IRS defines a retail sales facility as portions of a site where customers normally shop and are in close proximity to the retail site. That means storage lots that are open to customers and areas to which the sales staff normally directs customers are all considered part of the retail sales facility and not subject to capitalization.
Choice 2: Reseller without production
When a dealership is considered a “reseller without production,” it can deduct the cost of all labor (handling costs) performed on customer- and dealership-owned machinery. The dealership is required to include in inventory only the cost of parts associated with work being done, such as aftermarket parts installed on new machinery or parts used in repairing its own used machinery. Before the latest ruling, the IRS contended that a dealership had to capitalize handling costs incurred in working on its own machinery.
Apply even if your gross receipts are less than $10 million
Even if your dealership grosses less than $10 million per year, file for the safe-harbor options using Form 3115. Filing will protect you from the IRS’s harsher taxing of capitalization if your annual gross receipts ever do happen to reach $10 million. Even if you never meet the $10-million threshold, exceptions to the UNICAP small reseller method may be jeopardized if you don’t choose one or both of these safe harbors.
Filing Form 3115 for an accounting change is a one-time application. It must be filed with your dealership’s tax return, and a copy must be sent to the IRS national office. There is no filing fee, and you may file anytime from the beginning of the year of the change until you file the income tax return for the year of the change. The application asks many questions and requires you to attach copies of your capitalization calculations under both the old and new methods.
Potential tax savings
For most dealerships, choosing one or both safe-harbor options will not generally result in additional taxes. You may actually receive a one-time extra deduction. One dealer recently saw a $300,000 reduction in its 2010 taxable income by using the safe harbor elections and changing its capitalization method.
If your dealership has all facilities connected to retail facilities, you can now deduct all storage and handling costs for the retail facility from inventory costs. If you had previously been capitalizing these costs and file Form 3115 for the current year, you can deduct the costs on the tax return filed for the year of the change.
If you were charging parts and labor to machinery at or near retail prices on internal repair orders, the new rules may allow removal of all labor cost and all profit on parts. For most dealers, that would reduce taxes in the year they file Form 3115.
The ruling also allows you a $10 million average sales exclusion. The two other methods of calculating inventory—the production method and the service-cost method—do not have this exclusion.
Although you may generally be able to deduct all costs of handling and storing your inventory, the new IRS ruling still requires you to capitalize purchasing costs. In addition, you may also have facilities that do not qualify under the new rule—in which case storage and handling costs must be capitalized on inventory at those facilities.
Make sure your tax advisor understands what is at stake and considers taking advantage of these new dealer-friendly tax laws.
This article was originally published in Lift and Access magazine, a Rea & Associates enewsletter, September-October 2011.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.