The Pros, Cons & IRS Gotchas of an RFC

Transcription

1 The Pros, Cons & IRS Gotchas of an RFC CLAconnect.com 2016 TIADA Annual Conference & Expo July 26, 2016

2 Today s Objectives Is A Related Finance Company (RFC) Right For You? Tax Reasons Dealers Form RFC s Drawbacks To Forming An RFC Most Common RFC Mistakes Note Discount Limitations IRS 26 Point Audit Checklist For RFC s Tax Elections And Agreements Needed Financial Versus Tax Methods Of Accounting Provisions For Credit Losses 2

3 Is A Related Finance Company (RFC) Right For You? Are you paying too much in income taxes on income you haven t collected yet? Are you going to grow your portfolio substantially? Do you want legal and customer separation from your dealership for collection purposes? Can you pay for the notes at time of purchase? Do you want to do some estate planning and move assets out of your estate without using up your lifetime exclusion or annual gifts? 3

4 Tax Reasons Dealers Form RFC s Per the IRS: A "Related Finance Company" or RFC, is a financing company owned by an automobile dealership. It provides financing for customers that cannot obtain financing through normal channels. The customer is required to make payments usually at the dealership's location. This type of arrangement is usually advertised by the dealership as a "buy here pay here" plan. Generate cash flow thru tax deferral Normally need a minimum of $1 to $2 Million in customer notes to be beneficial Proper setup is the key to surviving IRS scrutiny the i s must be dotted and the t s crossed! 4

5 Tax Reasons Dealers Form RFC s (continued) Vehicle Sale Price $ 9,000 Less: Cost of Vehicle (5,000) Taxable Income $ 4,000 Federal Income Tax at 39.6% Rate $ 1,584 Down Payment Received $ 1,000 Cash Received $ 1,000 Cash Utilized ($5,000 + $1,584) (6,584) Negative Cash Flow $ (5,584) 5

6 Drawbacks To Forming An RFC Should have sufficient capitalization or financing to pay for notes purchased Must maintain a separate set of accounting books, financial statements and cash accounts Must set up another company and file additional income tax returns Should issue IRS form 1099-C s if required Should follow IRS audit requirements for an RFC Should complete combined financial statements each month end to see true operating profit Should have necessary business agreements completed Intercompany accounts must be reconciled monthly 6

7 Most Common RFC Mistakes Dealership does not take ownership of notes before they are sold to the RFC Notes not sold at Fair Market Value (FMV) RFC does not pay for the discounted notes at time of purchase Discount loss exceeds the gross profit of the car deal No agreements documenting transactions between the companies Intercompany accounts are not reconciled monthly Texas Incorrect ownership structure between dealership and RFC for deferring sales tax Texas Not filing Form AP-222 Texas Registration for Related Finance Company and paying $600 one-time fee to defer sales tax when notes are sold to the RFC Transferring the sales tax liability from the dealership s books to the RFC s books when the notes are sold at a discount to the RFC Having a holding company own the dealership and RFC (discount not allowed) 7

8 Most Common RFC Mistakes (continued) Incorrect Income Tax Structure: No - Sole Proprietor, L.L.P., Partnership, L.L.C. Yes - C corp, S corp The IRC regulations regarding the sale of notes to related parties as currently defined in IRC Sec 267 appears to apply only to corporations, but not to Sole Proprietors, LLP s, partnerships or LLC s! If forming entities we would suggest that you consider setting up the dealership and RFC as C corporations or LLC s and then immediately elect S corporation income tax status. Very often this will save the business owner self employment tax, as all of the income from the S corp is not self employment income. Generally all Sole Proprietor, L.L.P., Partnership and L.L.C. income will be considered self employment income to active partners. 8

9 Most Common RFC Mistakes (continued) What if I have already setup the dealership and RFC as an L.L.P., L.L.C. or Partnership? Consider making an election to be legally treated as an L.L.C. but taxed as a S corporation Requires filing federal form Election by a Small Business Corporation to be treated as an S corporation within 75 days of the beginning of the year. Note: Your tax advisor will have to determine no detrimental tax effects will occur for L.L.P. s, L.L.C. s or partnerships which have been operating for more than a year as a partnership this S corp election is a liquidation of the partnership. 9

10 Most Common RFC Mistakes (continued) Primary reasons for selling receivables to RFC are to obtain cash or to shift risk from the dealership to the RFC the notes can t be sold with recourse to the dealership Don t forget to review your discount percentage on a regular basis! Choose a potential purchaser that often actually purchases such a portfolio. Your discount percentage may or may not be the same for every year or pool of notes sold, due to economic conditions, changes in your underwriting criteria, etc. This is the most important element of having your RFC withstand IRS scrutiny. 10

11 Most Common RFC Mistakes (continued) Internal Revenue Code, Section 1.267(f) - 1(f) generally provides that losses on sales between related parties must be deferred until the property is sold to an unrelated party. Proposed Temporary Regulations provide an exception, for specific types of transactions. These Regulations provide if a company (dealership) acquires a receivable from the sale of goods or services to a nonmember (customer) at a gain, and if the company sells the receivable at fair market value to a related company (RFC), any loss or deduction of the company from its sale to a related company is not deferred under this section to the extent it does not exceed the company s income or gain from the sale to the nonmember that has been taken into account at the time the receivable is sold to the related company. 11

12 Note Discount Limitations 12

13 IRS 26 Point Audit Checklist For RFC s 13

14 IRS 26 Point Audit Checklist For RFC s (continued) 14

15 IRS 26 Point Audit Checklist For RFC s (continued) 15

16 IRS 26 Point Audit Checklist For RFC s (continued) 16

17 Tax Elections And Agreements Needed Should file federal income tax returns as a C or S corporation Specifically document business reasons in all legal documents, minutes and by-laws. Get an attorney to help you properly document your RFC Asset Purchase Agreement Shared Expense Agreement Common Paymaster Agreement Intercompany Note Agreements Lease Agreements 17

18 Financial Versus Tax Methods of Accounting For Income Tax Returns Dealerships should be on the accrual method of accounting due to inventory being carried on the books RFC s should normally be on the cash method of accounting to minimize taxable income For Financial Statements Dealerships should be on the accrual method of accounting to properly reflect operating income and net worth RFC s should normally be on the accrual method of accounting to properly reflect operating income and net worth 18

19 Financial Versus Tax Methods Of Accounting (continued) RFC s for income tax purposes establish an Unearned Discount Income account on the balance sheet when recording the purchase of notes at a discount from dealership Notes purchased are recorded at full principal value Unearned Discount Income (contra asset account) is set up on the balance sheet for the tax discount received at purchase As principal is collected, a percentage of the unearned discount is moved from the Unearned Discount Income on the balance sheet to Earned Discount Income on the income statement Unearned Discount Income on the balance sheet should be adjusted monthly to actual 19

20 Provision For Credit Losses RFC s should adjust and reclassify the Unearned Discount Income on the balance sheet to be a Provision For Future Credit Losses for financial statement presentation Set up the provision for future credit losses account based on the historical loss percentage you have incurred (static pool) Provides a more realistic view of your operations and income The difference between the tax and financial statement balances above is a GAAP Adjustment on the balance sheet and income statement The GAAP adjustment on the income statement is reversed for the tax return 20

21 Provision For Credit Losses (continued) As your principal balance changes, your provision for credit losses balance should change also This account should be adjusted monthly to be the expected loss percentage of the remaining principal you have on your books The monthly adjustment should be recorded on your income statement to a provision for credit losses If the adjustment is recorded correctly, operating income is properly reflected 21

22 Static Pool 22

23 RFC GAAP Adjustment Account 23

24 Combining Balance Sheet - Assets 24

25 Combining Balance Sheet Liabilities & Equity 25

26 Combining Income Statement 26

27 Questions? 27

28 David E. Keller, CPA, CFE Principal, Dealerships Main , Direct Cell Thank You For Your Time Today! CLAconnect.com twitter.com/ CLAconnect facebook.com/ cliftonlarsonallen linkedin.com/company/ cliftonlarsonallen 28