The 108th Congress is exploring a range of changes to the federal tax system—some are favored by the White House, others spring from ideas in vogue with the full range of congressional constituencies. Those changes, in whatever form they eventually take, along with a number of changes made to the tax laws during President George W. Bush’s first term, will have a significant impact on the tax bills—and penalties—faced by every collision repair shop in 2005.
No matter what 2005 brings, those recent tax code changes may affect your business now. In view of this, what does the year 2005 hold for you and your collision repair operation?
Coming attractions
The centerpiece of last year’s major tax-cutting legislation created a 3 percent tax rate cut for “manufacturers.” Our lawmakers’ extremely broad definition of “manufacturer” included both traditional manufacturers as well as so-called “producers,” in the areas of construction, engineering, energy production, computer software and films and videotapes, and even the processing of agricultural products. However, whether that tax rate reduction will apply to many collision repair shops remains to be answered.
Far more body repair shops—and their owners—will benefit in 2005 from the newly raised threshold for Section 179 write-offs from $25,000 to $100,000. This special, first-year expensing write-off for equipment costs is reduced by the amount by which the cost of qualifying property placed in service exceeds $400,000.
Originally designed as a temporary measure to stimulate the economy, the write-off was scheduled to drop back to $26,000 in 2006. Not only have industry groups managed to influence lawmakers to extend the higher caps through 2007, the new law also indexed the threshold amounts for inflation. In 2004, it was $102,000, with a $410,000 cap. This change carries the indexing through to 2007 as well.
It would be easier to understand this issue if we showed an example of how the deduction works. Unfortunately, there are so many variables between businesses that no real world example would fully illustrate how it works.
In addition, any example would have to include warnings about the advantages of a financially-troubled shop ignoring this write-off to generate bigger deductions down the road when taxable income increases. That would further complicate the picture.
On the depreciation front, lawmakers created a 15-year recovery period for qualified leasehold improvements. Thus, any operator who modifies, adapts or adds to his or her body shop operation’s business premises in 2005, (between Oct. 22, 2004 and before Jan. 1, 2006), will qualify for a 15-year write-off period for the cost of the improvements.
The old rules required leasehold improvements or additions to be depreciated using straight-line depreciation during the same 39-year period as business property. A qualified leasehold improvement is defined as an improvement to the interior of a building, made by either the lessor or the lessee and placed in service more than three years after the building was first placed in service.
As a result of last year’s tax law changes, many collision repair shop operators may want to change their business entity in 2005. Despite the popularity of limited liability companies (LLCs) and other partnership-type entities, S corporations remain the fastest-growing type of business entity. A collision repair business operating as an
S corporation passes through income and loss to shareholders. S corporations are most appropriate for small business owners and entrepreneurs who want to be taxed as if they were sole proprietors or partners. The shareholder takes into account their shares of these items on their individual tax returns, but avoids some of the liability issues of a partnership.
Last year’s law changes reformed and simplified the tax treatment of S corporations. Under the old law, most family members were treated as separate shareholders, limiting the collision repair business’s ability to diversify its investors and, therefore, better withstand business fluctuations.
The new law allows family members to elect to be treated as one shareholder for voting purposes or to maintain its S corporation status by determining the number of shareholders. It also increases the maximum number of S corporation shareholders from 75 to 100.
Paying the piper
According to lawmakers, the cost of last year’s tax cuts to the U.S. Treasury will be offset by closing a number of tax loopholes as well as with other revenue-raising measures.
Among the loopholes closed in 2005 is one that allowed some small business owners to deduct up to $100,000 of the cost of luxury SUVs on their income tax returns. Because the vehicle caps on depreciation do not apply to cars or trucks weighing more than 6,000 pounds, steel distributors could deduct up to the full cost of the SUV immediately, as a Section 179 expense. Under the new law, the deduction for vehicles weighing not more than 14,000 pounds is capped at $25,000, effective for SUVs placed in service after Oct. 22, 2004.
As for those common tax tricks used by so many small businesses to shelter profits and proceeds from the sale of their businesses, in 2005, both collision repair businesses and individuals will be required to disclose to the IRS details about their participation in tax shelters. Last year’s changes also boosts the penalties for failing to do so.
Penalties for failing to report a tax shelter apply not only to so-called “listed” transactions, those known to the IRS, but also to what are termed “abusive transactions.” The penalty is $10,000 for an individual ($50,000 for businesses). If the shelter is a “listed transaction” the penalty skyrockets to $200,000 ($100,000 for individuals).
For those owners who may be less than truthful on their collision repair business or personal tax returns, the new law also created an accuracy-related penalty for both reportable and listed transactions. Lawmakers granted the IRS discretion in applying the penalties. Fortunately, the IRS is likely to continue its “carrot-and-stick” approach with taxpayers suspected of participating—or promoting—abusive shelters.
Last year’s revenue-raising provisions are, for the most part, permanent while the majority of tax cuts have only a temporary life. Will these and other tax cuts enacted in Bush’s first-term be made permanent? Will Congress tinker with the tax code or make sweeping changes? The year 2005 should be an interesting one as collision repair business owners scramble to plan in the face of this uncertainty.
* This article is not meant to serve as personal tax advice. If seeking tax counseling, contact a tax professional in your area.
