By Peter Goodrich, Tax Services, Rosenfield & Co, PLLC
There has been a lot of speculation regarding the Volkswagen emissions scandal, the magnitude of the settlement payouts and their respective tax implications to dealers. While the taxability of these payouts has not yet been solidified, there is a position that will likely be taken by the Internal Revenue Service on the subject matter.
In late September of this year, more concrete legal settlement plans have materialized where Volkswagen will have to pay up to $1.208 billion in assessed damages assuming all 652 U.S. dealers participate in the class action lawsuit; dealers who opt-out of the class action lawsuit may go after Volkswagen separately. The total settlement payout is presumably divided amongst all 652 dealers coming out to a total average dealer payout of approximately $1,850,000 (rounded down); some dealers will receive more and some dealers will receive less. Monthly payments have been made in late 2015 and the formula for estimating the respective total dealer payout is as follows:
Total VW Dealer Payout = 71 x (November 2015 Payment Received)
If you completed the individual release of claims related to the class action lawsuit, you will receive an upfront 50% payout on the $1,850,000 or $925,000 (on average), within 30 days of final approval of the settlement or within 30 days of the “opt-out date.” The remaining 50%, or $925,000, will be paid in 18 equal monthly installments following the initial 50% lump sum payout. It is important to note that the aforementioned are ballpark figures and these calculations and formalities only apply to those owning or operating VW-branded franchise dealerships as of September 18, 2015.
Now let’s get down to brass tacks. From an IRS standpoint, the VW payouts will most likely be rendered ordinary income. This means that the income will be taxed at the taxpayer’s respective income tax bracket which depends on overall taxable income applicable in the pertinent tax year. Being that these payouts themselves are large in magnitude, the tax rate for individuals and corporations receiving these payouts will likely be 39.6% and 35% respectively.
The reason why these payouts will unlikely be rendered capital gains (which consequently would be taxed at a lower rate) is because these recovery amounts are “for alleged diminution in value of the capital investment and goodwill in their franchises,” or in other words, for the loss in value of the VW-branded franchise dealerships across the board. There is no sale or exchange of property; these settlement payouts are unilateral and will likely be considered ordinary income in nature.
Therefore, it is important to do some tax planning in order to mitigate, or at least be prepared for the pending tax liability that is looming. As a dealer, if you are planning on incurring some massive costs, it would be a good idea to expense them in the year that you are receiving these payouts. If you have bad investments where you can take some losses and you are adamant about selling, this would be the ideal time to get out of such investments. While there are other ways to minimize the tax liability, you should consult your tax advisor since different scenarios yield different tax strategies.
