Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

of a deduction (Treas. Reg. section 1.446-1(e)(2)(ii) and Rev. Proc. 91-31, 1991-1 C.B.
566). Rev. Proc. 97-27 provides a definition of "method of accounting." It states: "* * * the
relevant question is generally whether the practice permanently changes the amount of
taxable income * * *." Consistent treatment is established by using an improper method for 2
or more tax years (Rev. Proc. 97-27 and Rev. Rul. 90-38, 1990-1 C.B. 57) and a proper
method for 1 year (Treas. Reg. section 1.446-1(e)(1)).
Under the method of accounting employed by most dealerships, only a "net" amount of the
retail sale price of a mechanical breakdown contract is reported in the taxable year of the sale
of the contract. This "net" represents the amount by which the sales price exceeds the
insurance and administrative expenses. This method results in the exclusion from income, or
early deduction of, expense items that properly should either be amortized over the life of the
mechanical breakdown contract, or be deducted as economic performance occurs.
Requiring the dealer to change from expensing insurance premiums to amortizing them is a
change in accounting method. This change affects the timing of the deduction of a material
item.
A new dealership filing its first return has not established an accounting method where it
erroneously deducted in 1 year the entire premium for a multi-year period.
Under IRC section 481(a), when computing taxable income for any taxable year, "* * * (1) if
such computation is under a method of accounting different from the method under which the
taxpayer’s taxable income for the preceding year was computed then (2) there shall be taken
into account those adjustments which are determined to be necessary solely by reason of the
change in order to prevent amounts from being duplicated or omitted * * *."
Treas. Reg. section 1.481-1(a)(1), provides that a change in method of accounting to which
IRC section 481 applies includes a change in the over-all method of accounting for gross
income or deductions, or a change in the treatment of a material item.
IRC section 481(b) provides for a limitation on tax where the change in method of
accounting is substantial. This section allows for a computation of tax over 3 years if the
method of accounting changed was used in 2 preceding tax years and the increase to taxable
income for the year of change exceeds $3,000.
When adjustments are made under IRC section 481(a), the statute of limitations is not an
issue. IRC section 481 provides that taxable income for the year of change must be computed
by taking into account all adjustments necessary to prevent items from being duplicated or
omitted. This includes amounts that would otherwise be barred by the statute of limitations.
Graff Chevrolet Company v. Ellis Campbell, Jr., 343 F.2d 568 (5th Cir. 1965).
A second adjustment under IRC section 446(b) accounts for the difference in taxable income
determined under the new method of accounting for the year of change as compared to the
old method.
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