Floor Plan Financing Provision Should Favor Taxpayers, Firm Says

February 26, 2019

Internal Revenue Service
CC:PA:LPD:PR (REG-106089-18)
Room 5203 P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments on proposed regulations concerning the limitation on deduction for business interest expense (REG-106089-18)

Dear Sir or Madam:

On November 26, 2018, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “IRS”) issued notice of proposed rulemaking REG-106089-18 regarding the limitation on deduction for business interest expense under Section 163(j) (the “business interest limitation”).¹ We, CliftonLarsonAllen LLP (CLA), are pleased to provide comments and recommendations regarding the provisions in the proposed regulations associated with floor plan financing interest.²

CLA respectfully requests Treasury adopt the following recommendations in the final regulations: (1) remove floor plan financing interest expense as a subtraction in computing adjusted taxable income by removing Prop. Treas. § 1.163(j)-1(b)(1)(ii)(B); and (2) clarify that taxpayers have the option to forego taking floor plan financing interest into account under IRC § 163(j)(1)(C) thereby treating such interest as regular business interest and preserving a dealership's ability to take bonus deprecation with respect assets used in the business.

Overview of Floor Plan Financing Interest Expense

The amount allowed as a deduction for business interest expense is not to exceed the sum of:

Business interest expense is any interest paid or accrued on indebtedness properly allocable to a trade or business. The term does not include investment interest within the meaning of IRC § 163(d).⁴

ATI is the taxable income of the taxpayer computed without regard to:

The amount computed above is further adjusted as provided by the Secretary.⁶

Floor plan financing interest is interest paid or accrued on debt used to finance the acquisition of motor vehicles held for sale or lease and secured by the inventory so acquired.⁷ All floor plan financing interest expense is treated as business interest expense.⁸

Bonus depreciation is not available with respect to any property used in a business which has taken floor plan financing interest into account in computing its business interest limitation under IRC § 163(j)(1)(C).⁹

Floor Plan Financing Interest Expense Should Not Reduce ATI

Congress provided an opportunity for dealerships to enhance their interest expense deduction for floor plan financing interest expense. As discussed below, we request that floor plan financing not reduce ATI because (i) the adjustment is inconsistent with the statute and (ii) the adjustment is inconsistent with the ordering implied by IRC § 168(k)(9)(B) and the General Explanation of Public Law 115-97¹⁰ (the “Blue Book”).

Adjustment is inconsistent with the statute

The statute provides that business interest expense is added back in computing ATI. The proposed regulations reduce ATI by floor plan financing interest expense.¹¹ The statute authorizes the Secretary to make “other adjustments” in computing ATI but does not authorize the Secretary to modify the adjustments set forth in the statute. Congress specified that business interest expense (which includes floor plan financing interest) should be added back in computing ATI, so the adjustment for floor plan financing interest expense provided in the regulations appears to contravene the intent of Congress.

Adjustment is inconsistent with ordering implied by IRC §168(k)(9)(B) and the Blue Book

Congress increased the business interest expense limitation for floor plan financing interest as a benefit for qualifying taxpayers. Congress provided an offsetting cost for this provision for dealerships who utilize the benefit: IRC § 168(k)(9)(B) prohibits dealerships from claiming bonus depreciation if floor plan financing interest is taken into account under IRC § 163(j)(1)(C). The proposed regulations reduce ATI for floor plan financing interest, which suggests that the ATI component of the business interest limitation is taken into account after the floor plan financing interest component. In other words, floor plan financing is deducted first, followed by net business interest expense (other than floor plan financing interest), limited to 30 percent of ATI (as reduced by floor plan financing interest expense). If that were the correct interpretation, all dealerships with floor plan financing interest expense (not already exempted from IRC § 163(j)(9) due to the gross receipts exception under IRC § 163(j)(3)) would be prohibited from computing bonus depreciation. However, that would make the last phrase of IRC § 168(k)(9)(B) meaningless. There would be no reason for the “if” phrase; every dealership (not exempted by IRC § 163(j)(3)) with even $1 of floor plan financing interest would have “taken into account” the floor plan financing under IRC 163(j)(1)(C).

We conform IRC §§ 168(k)(9)(B) and 163(j)(1) by viewing the business interest limitation as a sequential computation following the order provided in IRC § 163(j)(1), treating floor plan financing as coming last in the determination. This interpretation is consistent with explanation set forth in the Blue Book. If the taxpayer has sufficient business interest income and adjusted taxable income, the taxpayer would not take its floor plan financing interest into account under IRC § 163(j)(1)(C). This is illustrated in the following example, which compares the result using Form 8990 (which appears to conform to the proposed regulation) and the Blue Book explanation.

Assume that the taxpayer has taxable income of $100, business interest income of $15 and business interest expense of $30, of which $10 is floor plan financing interest expense. Under these assumptions, the taxpayer would qualify to fully deduct business interest expense regardless of whether the taxpayer followed the proposed regulations or the Bluebook. Under the proposed regulations, however, the dealership would be denied bonus depreciation, because the floor plan financing was taken into account (first) in the computation of the IRC § 163(j) limit. This illustration of the Bluebook method of computing the business interest limitation confirms that the dealership is not penalized for securing its financing with its inventory of motor vehicles.

Example 1

	Form 8990	Blue Book
Income less expenses	115	115
Business interest income	15	15
Business interest (not floor plan)	(20)	(20)
Floor plan interest	(10)	(10)
Taxable income	100	100
Determination of Adjusted Taxable Income
Taxable income	100	100
Less business interest income	(15)	(15)
Add back:
Business interest (not floor plan)	20	20
Floor plan interest	10	10
Subtotal	115	115
Less Floor plan interest	(10)
Adjusted taxable income	105	115
30% of ATI	32	35
Total interest deduction:
Business interest income	15	15
Business interest expense (w/o floor plan)	20
Business interest (could include floor plan)		30
Floor plan financing interest expense	10	—
Interest expense limitation (maximum)	45	45
Deductible interest expense	30	30

The mandatory treatment of floor plan financing as a separate category, deducted first in the computation, penalizes dealerships that do not need to account for floor plan financing interest as a separate category. In the above example, all business interest is deducted within the 30 percent of ATI limit. Floor plan financing interest expense was not taken into account. The ability to deduct bonus depreciation is preserved.

Recommendation

The floor plan financing interest expense provision should be interpreted in a taxpayer favorable manner. Final regulations should reflect the intent of Congress so that dealerships are not penalized for securing debt with inventory; ATI should not be reduced by floor plan financing interest.

Taxpayers Should Be Able to Choose Treatment of Floor Plan Financing Interest Expense

As further discussed below, taxpayers should have the opportunity consistent with Blue Book examples to utilize floor plan financing interest to increase business interest expense limitation or choose to forgo the enhanced limitation so they can take advantage of bonus depreciation.

Floor plan financing is part of business interest expense and absent a special rule would be subject to the business interest limitation.¹² Congress recognized that dealerships — similar to taxpayers operating real estate and farming trade or businesses — incur substantial interest costs to finance their inventory and provided dealerships with an opportunity to deduct their floor plan interest without limitation. The special treatment of floor plan financing interest is intended to be beneficial.

In some instances a dealership may prefer to have a more restrictive business interest limitation and retain eligibility to claim bonus depreciation in the same manner as a business that does not have floor plan financing (e.g., by not taking floor plan financing interest expense into account under IRC § 163(j)(1)(C)). As one example, a dealership with a low amount of floor plan financing interest and substantial fixed asset additions may prefer to claim bonus depreciation in lieu of the additional business interest limitation. Real estate and farming businesses can choose not to apply the business interest limitation.¹³ The alternative example on page 127 of the Bluebook supports an interpretation that the special treatment of floor plan financing interest is optional. Consistent with the Bluebook interpretation, the regulations should provide taxpayers the option to exclude floor plan financing interest in computing the limitation.

Assume the same business interest income, business interest expense (including floor plan financing interest expense) as in Example 1 above. Rather than taxable income, the taxpayer reports a loss of $130.

Example 2

	Form 8990	Blue Book	Ignore Floor
Income less expenses	50	50	50
Business interest income	20	20	20
Business interest (not floor plan)	(150)	(150)	(200)
Floor plan interest	(50)	(50)
Taxable income	(130)	(130)	(130)
Determination of Adjusted Taxable Income
Taxable income	(130)	(130)	(130)
Less business interest income	(20)	(20)	(20)
Add back:
Business interest (not floor plan)	150	150	200
Floor plan interest	50	50
Subtotal	50	50	50
Less Floor plan interest	(50)
Adjusted taxable income	—	50	50
30% of ATI	—	15	15
Total interest deduction:
Business interest income	20	20	20
Business interest expense (w/o floor plan)	—
Business interest (could include floor plan)		15	15
Floor plan financing interest expense	50	50	—
Interest expense limitation (maximum)	70	85	35
Deductible interest expense	70	85	35

The opportunity is implicit in the “if” phrase of IRC § 168(k)(9), as discussed above. The taxpayer that chooses not to take into account floor plan financing interest expense forgoes the additional interest expense deduction, which becomes a carryforward of disallowed business interest.¹⁴ That is, the taxpayer has a choice:

The above information and the statutory language is more than sufficient to provide guidance to taxpayers regarding the choice of treating qualifying interest as floor plan financing interest expense or as regular business interest expense. However, if Treasury and IRS do not agree with this interpretation of the statute, seeking separate authority for that interpretation, we offer it here.

Providing the opportunity for taxpayers to choose not to claim a deduction has precedent. In the so-called repair regulations, the taxpayer has a year-by-year choice of applying a de minimis safe harbor.¹⁵ This allows the taxpayer to choose not to capitalize an asset, instead following an accounting expensing policy to treat qualifying amounts paid for the acquisition or production of a unit of tangible property as a material and supply.

The IRS granted taxpayers administrative relief from the required accrual method of accounting for taxpayers who buy and sell merchandise, meeting gross receipts thresholds.¹⁶ There is no statutory authority for the IRS to have granted this relief.

The IRS granted taxpayers a safe harbor for determining deductible expenses for a qualified business use of a dwelling unit.¹⁷ The safe harbor is an alternative to the calculation and allocation of actual expenses otherwise required by IRC § 280A.¹⁸ Presumably, this means that a taxpayer otherwise entitled to a larger deduction may forgo the larger deduction to claim the safe harbor.

Taxpayers were provided a safe harbor to allocate 70 percent of success-based fees paid in business acquisitions or reorganizations to activities that don't facilitate the transaction and deduct the fees currently.¹⁹ Presumably, this means that the taxpayer need not deduct a greater expense, even though entitled to do so.

Recommendation

The regulations should provide an opportunity for taxpayers to treat floor plan financing interest expense the same as any other business interest expense. Taxpayers that do not need or desire the special allowance of IRC § 163(j)(1)(C) should not be penalized when their inventory is collateral for debt. Congress did not intend to restrict dealerships from bonus depreciation if the taxpayer does not take floor plan financing interest expense into account (separate from other business interest expense).

As discussed above, we respectfully request that Treasury and the IRS remove floor plan financing interest expense from the list of subtractions in Prop. Reg. § 1.163(j)-1(b)(1)(ii). The final regulations should be written in a taxpayer-favorable manner, by following IRC § 163(j)(1), limiting business interest expense to:

In addition, the final regulations should provide an opportunity for taxpayers to treat floor plan financing interest expense as regular business interest expense and carryover any disallowed interest to future years.

Thank you for your consideration of our comments. We welcome the opportunity to discuss them further. Please direct questions to Chris Hesse (chris.hesse@claconnect.com, 612-397-2071), John Werlhof (john.werlhof@claconnect.com, 916-218-7128) or David Wiggins (david.wiggins@claconnect.com, 314-925-4316).

Sincerely,

CliftonLarsonAllen LLP
Minneapolis, MN