Dealer buy-sell agreements and the taxpayer relief act of 1997

David S. Bullock

NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided.

Another year and another federal tax bill: Does the Taxpayer Relief Act of 1997 (TRA ’97) hold any gems for tax planners, or is it merely a fiscal reshuffling of political whims with little effect on a dealership buy-sell? In some ways the effects can be immediate and translate directly to the bottom line. In other ways, the new tax law provides future opportunities with potential subtleties you should be aware of.


Of all the changes introduced, the most publicized is reduction in the long term capital gains rate to 20% for sales after May 6, 1997. With the decrease, however, the defined holding period of what is a long term capital gain has expanded to assets held for more than 18 months and a new third mid-term gain category is created for assets held more than 12 months but not more than 18 months. These mid-term gains are taxed at the old 28% rate.

In addition, the rate reduction from 28% to 20% applies to regular tax and alternative minimum tax (AMT). Why should you care about AMT tax rates? With previous law, an increasing number of taxpayers wound up paying AMT because the highest AMT rate (28%) did not change due to capital gains, causing the regular rate and AMT rate in some cases to be the same. This whipsaw effect of capital gains on AMT calculations would appear to be lessened by the new law.

Is the capital gains rate available for all taxpayers, both individual and corporate? The answer is No. Capital gains rate provisions have always been an individual, estate and trust tax benefit, not a corporate one. This of course is not without further clarification as it relates to C corporations and S corporations. If a dealer C corporation experiences a long term capital gain through the sale of a capital asset like goodwill, the corporation will pay the regular corporate tax rates on that capital gain as it does on other ordinary income. An S corporation on the other hand, would pass that same capital gain through to shareholders who could benefit from the newly reduced rate.

How does all of this effect a dealership sale? The tax benefit Congress has dangled before our eyes for so long has finally been realized. Dealers who sold before TRA ’97 and experienced individual long term capital gains still may have benefited from differences of the highest marginal individual rate of 39.6% compared to 28%. Now this difference has been enhanced to 19.6%, nearly half the top regular rate. On a capital gain of $2,000,000, the federal tax savings from being categorized as a long term capital gain over tile regular tax could be as much as $392,000; not a bad deal.

If taxation of new long term capital gains are such a windfall, how does it apply in a buy-sell? Clearly, part of the art of negotiating a deal up front is to, where possible, categorize taxable income in a manner to take advantage of the lowest tax rates. Capital gain is only generated by the sale of a capital asset. Typically, this includes sale of dealership real property, corporate stock, and goodwill. Rules relative to recapture of depreciation oil business property have not changed. Certainly these factors are worthy of serious thought when considering an asset or stock sale.

The new law also expands the benefits of selling “qualified small business stock” enacted in 1993. Capital gain realized from the sale or exchange of qualified small business stock can now be deferred entirely by tax-free rollover, similar to a 1031 exchange transaction, if other qualified small business stock is purchased with proceeds within 60 days of the sale. For many, this provision may be out of reach because of tile restrictions oil qualification and the preference of buyers to purchase assets) not stock. However, given the right set of circumstances, some will reap significant advantages from this option.


The expansion of the lifetime exemption for gift and estate tax purposes should impact tax planning for all individuals who currently own a dealership interest. The increase of the exemption will take place over time, but when in full force, will exclude up to $ 1,000,000 of value from a gross taxable estate and up to $1,300,000 for qualified family-owned businesses.

Although the qualified family-owned business exclusion ceiling is fixed at $1,300,000, it is NOT in addition to the regular applicable exemption amount. The benefit of a qualified family-owned business exclusion merely increases the standard applicable exemption amount to $1,300,000. As an example, in the year 2001, the qualified family-owned business exclusion benefit would be equal to $625,000, which is the additional amount to increase the standard applicable exemption to $1,300,000. Eligibility for the family-owned business exclusion may be difficult for many estates. Complex ownership rules, business valuation adjustments, liquidity tests and participation rules are required.

Year Exemption Applicable Amount Applicable Credit Amount
1997 $600,000 $192,800
1998 $625,000 $202,050
1999 $650,000 $211,300
2000 $675,000 $220,550
2001 $675,000 $220,050
2002 $700,000 $229,800
2003 $700,000 $229,800
2004 $850,000 $287,300
2005 $950,000 $326,300
2006 $1,000,000 $345,800

To qualify, estates must meet the following conditions for the additional exclusion:

(1)The decedent must be a U.S. citizen or resident.

(2)The adjusted value of the qualified family-owned business included in the decedent’s estate must exceed 50% of his or her adjusted gross estate.

(3)The decedent or members of his or her family must have materially participated in the operation of the business for at least five years during the eight year period prior to the decedent’s death.

(4)The executor of the decedent’s estate must elect the special tax treatment and file a tax recapture agreement signed by each person having interest in the qualified family-owned business. The tax recapture agreement imposes potential personal liability to qualified heirs receiving family-owned business property should a specified recapture event occur within 10 years of the decedent’s death. The recapture tax, which reclaims the estate tax benefit derived from the exclusion, is subject to various conditions and exceptions.

Often buy-sell agreements are an integral part of estate plans and succession arrangements. As the estate and gift tax exemption increase begins to take effect, consideration should be made to maximize its tax planning potential.

Other less dramatic and more narrow applications effecting buy-sell agreements are present in the new law. These include the inability of IRS revaluation of lifetime gifts for estate tax purposes, gain recognition on distributions of controlled corporation stock, and changes in estimated tax safe harbors.

In all, TRA ’97 present several positive opportunities for sellers of automobile franchises which may have significant effects on the structure of buy-sell agreements and estate plans. This article is provided to alert readers to selected changes in income, gift and estate taxation and is not tax or legal advice or any form of recommendation. Readers should consult a qualified tax professional regarding their specific tax issues.

This article was written in 1998.

Mr. Bullock is a C.P.A. with the firm of Parke, Guptill & Company, LLP, with offices in West Covina and San Diego. He can be reached at 626-339-7341.