What Impending Tax Changes Could Mean for Dealership Valuations

August 19, 2021

With the shift in presidential administrations in Washington, probable changes to the US tax code are on the near horizon. 

Looking at the tax plans laid out by the Biden administration, we can gauge how potential changes in the tax code may affect businesses throughout the country, including how they may impact automotive dealers and dealership valuations.

First, Know: Nothing is Final at this Point

Before we get into the details, it’s important to remember these are proposals that have not yet been through Congress. They’re likely to go through several twists and turns before they return to the president’s desk for his signature.

With only a nine-seat Democrat majority in the House of Representatives and an even 50-50 balance in the Senate (with Vice President Harris available as the tie-breaking vote), any tax reforms will be an arduous process. So if you’re thinking of buying or selling one or more dealerships this year, don’t make any changes to your business plans yet and stay focused on the fundamentals – those aren’t likely to change.

What We Know So Far About Biden’s Tax Plan

There have been several specific tax changes floated by the Biden administration so far. Here we’ve broken them into those that would directly affect dealership valuations and changes that wouldn’t directly affect valuations but would likely apply to dealership owners.

Tax Measures That Could Directly Affect Dealership Valuations

Increase in corporate tax rates 

The current 21% corporate tax rate would increase to 28% under the terms of the Biden proposal. This measure is estimated to raise a sizable $1.3 trillion in tax revenue, but it would do so by cutting into corporations’ revenues.

Analysis: This change would almost certainly reduce valuations of dealerships with a corporate structure. When applied to the S&P, this increase alone is estimated to cut earnings by 9%.

Minimum tax on book income

There is a proposed 15% minimum tax on companies that have a book income of over $100 million.

Analysis: If your dealership’s book income is over the $100 million mark and you were paying less than 15% tax on it, you will be getting a tax increase. This could reduce a valuation of your dealership based on total profits, though probably not in a major way.

Capital gains tax increases

A proposal calls for capital gains on high income (single returns earning over $500,000 and joint returns earning over $1 million) to be taxed at regular income rates. For high earners, this would raise the rate from 20% to 39.6%. This measure is projected to raise $500 billion in tax revenues.

Analysis: If you’re selling your dealership, this increase will put a large dent in your after-tax proceeds. If you have owned your dealership for a long period, your blue-sky value could also be subject to the new capital gains rate. This means a potential tax of $1 million or more on the blue sky alone, depending on your dealership’s value.

This measure could also hurt when heirs inherit assets, applying to estate assets in excess of $1 million. Heirs may have to sell some of the assets to pay those taxes, so this could require some extra maneuvering when it comes to succession planning.

This increase wouldn’t necessarily affect dealership valuations based on profitability, though it could lead sellers to increase their asking prices to compensate for the capital gains increase.

Measures That Could Affect Individual Income or Indirectly Affect Dealership Valuations

Phasing out of deductions

The proposed tax changes include two phase-outs of tax deductions currently available to high earners. One measure is a reinstatement of the “Pease limitation” on itemized deductions for individuals earning over $400,000—which was lifted in the 2017 Tax Cuts & Jobs Act. 

The other would phase out the qualified business income (QBI) deduction that currently allows owners of pass-through entities (non-C-corporations whose profits are taxed as the owner’s individual income) to deduct 20% of their taxable income. This deduction would no longer be available to individuals earning over $400,000 per year. 

Analysis: Since these changes would apply to high earners who make over $400,000 per year, they may affect dealership principals. As a dealership owner, they could cost you, on both the individual and business sides.

These measures would increase taxes for owners of S corporations and partnerships. This could serve to indirectly lower dealership valuations because, after taxes, the owner’s investment in the business would be less profitable—so dealership buyers would be slightly less inclined to pay a high price.

Loss of step-up basis on inherited assets

Instead of the current “step-up” provision that values inherited items at their original purchase price for tax purposes, the proposed changes would value assets at what they’re worth at the time of the decedent’s death.

Analysis: Heirs to dealerships would have to pay taxes on it at a higher dollar amount for their inheritance. Similar to the capital gains increase, this will put pressure on heirs to liquidate the assets if they cannot afford the tax bills. While this change may make it trickier to pass down your dealership, in the case of a normal sale to a non-family member, this measure would not affect dealership valuations.

Other proposed changes

Several additional proposed changes are likely to affect high earners, including most dealership owners, but are unlikely to affect dealership valuations in any significant way. They include: 

  • Changing tax rules on 1031 like-kind real estate exchanges so that they’re only eligible for deferred capital gains up to $500,000 per year per individual (all sales or exchanges above that amount would be taxed).
  • Changing depreciation rules for commercial and multifamily real estate, including real estate investment trusts (REITs).
  • An IRS funding of $1.2 billion, to allow the agency to more closely scrutinize corporations and wealthy individuals.

Analysis: Real estate investors and business owners will fight to keep their existing tax benefits, so those measures are not guaranteed to make it into law exactly as proposed. The same goes for the additional IRS funding, which will be opposed by Republicans in Congress.

Bottom line — Changes are likely to affect dealership valuations in 2022

Even though none of these tax code changes are currently in effect and their final form remains unknown, it looks likely that some of them will become law before the 2022 congressional elections. Once passed, they’ll begin to make a difference in the market, even before they take effect.

Overall, these changes could take an additional bite of as high as 25% from the proceeds of a dealership sale. That’s a lot, and it will almost certainly affect dealership valuations.

On one hand, sellers may be inclined to raise their asking prices to compensate for the required tax payments. On the other hand, buyers may be less inclined to pay high prices, because taxes will cut into their return on investment. This pull in opposing directions has the potential to slow down the current accelerated pace of the buy-sell market.

If you’re currently in the process of buying or selling a dealership, many financial consultants recommend that you complete that process in 2021 if possible.

The current automotive M&A environment is extremely healthy, and it’s not going to stop. However, dealership sales can take 6-12 months to complete, and it may be advantageous to act sooner rather than later.

It’s never too early to have a discussion with your tax consultant or CPA about these potential changes and how they will affect you and your plans for the future, both individually and as a dealership principal. This way, you can be prepared with some options and strategies when the final changes become known.

DCG Acquisitions is here for your dealership buy or sell transaction

If you’re considering a dealership sale or purchase, it’s also a great time to contact DCG Acquisitions. We’re one of the country’s leading, fastest-growing automotive M&A firms. Our network of connections – with manufacturers, lenders, dealership buyers and sellers, and more – helps us build you a qualified and competitive environment on either side of the sale.

Contact DCG Acquisitions to speak directly with an automotive M&A and valuation specialist. Learn how our expertise can get you more out of your next dealership acquisition or sale.