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

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Chapter 12 Extended Service Contracts – "Dealer Reserve Accounts" When a dealership acts as obligor on an extended service contract it may chose to cover its risk through an arrangement other than insurance such as by placing a portion of the sales price in an "reserve" (also known as an escrow or trust account) maintained by an administrator. The dealer generally, establishes the selling price of the contract, retains a portion as "commission" and forwards the remainder to an administrator. The administration agreement may require the establishment of an "escrow" "reserve" or "trust" account to provide for the dealer’s obligations under the contract. The administrator acts as "trustee" of the funds and retains a portion of the funds submitted to it as a fee for its services. Funds in the "reserve" account are used to meet the obligations of the dealer including payment for repairs to covered vehicles. The amounts placed in reserve may be based on actuarial standards and the dealer may have certain sales requirements. When certain conditions are met, the dealer is entitled to a return of unused reserve funds at the expiration of the extended service contract. Unless the contract is cancelled, the retail customer does not receive any portion of the unused reserve funds, even if no repairs are made to the covered vehicle. Often the funds deposited in the reserve accounts earn investment interest that is deposited into the reserve. Funds placed in the escrow account do not constitute payments for insurance. Sometimes the program includes a provision for purchasing "stop loss" or "excess loss" insurance that may pay for claims if the reserve or escrow account does not contain adequate funds. The payments for stop loss or excess loss coverage may constitute payments for insurance. Dealership that sell service contracts and cover their risk under a reserve program must include the entire sales price of the extended service contract in income in the year the contract is sold. Payments to the reserve account do not constitute payments for insurance. The dealership may deduct payments for claims as incurred. Reserve, escrow, or trust extended service contract plans do not qualify for the Service Warranty Income Method of reporting income. The Tax Court addressed similar issues in Hinshaw’s, Inc. above and Rameau Johnson et al. 108 T.C. No. 22, Affirmed by 8th Circuit Court of Appeal 84 AFTR2d. Par. 99-5073; No. 98-1324 (July 21, 1999). In Rameau Johnson, the dealerships retained a portion of the contract price as profit and forwarded the remainder to the administrator for deposit in an escrow account, for payment of administration fees, and for the purchase of excess loss insurance. The escrow amounts earned investment income. Dealers received distributions from the escrow accounts, within certain limitations, for specified purposes such as compensation for covered repairs, cancellations, and the release of "unconsumed reserves" at the expiration of a contract. The dealerships included in current income the profit portion of the contract price but included the escrow amounts as they were released. 12-1
The Court ruled that when the dealership sold an extended service contract it acquires a fixed right to receive, and must currently include in gross income, the portion of the contract price deposited in escrow. The reasoning of Commissioner v. Hansen, 360 U.S. 446 (1959), controls. The Court also ruled that the dealer is treated as the owner of the escrow account and must currently include investment income earned by the accounts in gross income of the dealership. 12-2
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Internal Revenue Service Market Seg
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Preface One of the goals envisioned
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Table of Contents Preface .........
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The Reinsurance Transaction .......
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Part 1 General Focus and Procedure
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1. Type A Return Information Schedu
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Percentage has gone down. The incre
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the principal shareholders to finan
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Rents $ 500,000 Interest $ 50,000 C
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Conclusion "Financial status" is on
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Chapter 2 Getting Started The key t
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entities and their purpose and rela
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It is recommended that officer comp
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Chapter 3 Standard Audit Index Numb
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Chapter 4 Books and Records Charact
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c. Reconcile (2): Beginning Trial B
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3 Repair Order Sales 4 Parts Sales
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Conclusion Although intimidating at
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Chapter 5 Balance Sheet Why do we c
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When an adjustment to a balance she
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Part 2 Inventory Chapter 6 General
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. Purchasing c. Handling, processin
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dealerships use specific identifica
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Chapter 7 LIFO Background Overview
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A Short History of LIFO Application
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improper inflation through unwarran
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Introduction Chapter 8 Computing LI
Page 55 and 56: The double extension index formula
Page 57 and 58: as one item, there would probably n
Page 59 and 60: (existing items) and non-comparable
Page 61 and 62: The current-year costs that can be
Page 63 and 64: Assuming the dealership elects LIFO
Page 65 and 66: matching of revenues and costs. Thu
Page 67 and 68: section 1.471-9. Both of these regu
Page 69 and 70: providing to the credit subsidiary
Page 71 and 72: Under elections made prior to Decem
Page 73 and 74: Base Year Cost 9112 $224,000 You ha
Page 75 and 76: BLS Sanity Check A simpler means to
Page 77 and 78: CYC = Current Year Cost. This is th
Page 79 and 80: Computation of 1993 Increment and R
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Page 83 and 84: Specific Identification Increment M
Page 85 and 86: which may be identified by a unique
Page 87 and 88: Step # 3 For each item category, ad
Page 89 and 90: Step # 10 Compute the total cost of
Page 91 and 92: 1991 Inventory Value at Current Yea
Page 95 and 96: Dealers may offer the contracts as
Page 99 and 100: 2. Principal/Obligor A principal is
Page 101 and 102: Rev. Proc. 97-38 provided for an al
Page 103 and 104: Contract Construction Generally, a
Page 105: Rev. Proc. 97-27 provides the admin
Page 109 and 110: Considerations for Forming a Produc
Page 111 and 112: The Reinsurance Transaction To illu
Page 113 and 114: insurance contract reinsured throug
Page 115 and 116: (1979). The Service’s position is
Page 117 and 118: While not all captive situations in
Page 119 and 120: 3. IRC section 845 tax avoidance 4.
Page 121 and 122: section, seemingly compliant arrang
Page 123 and 124: 2. By owner A dealer may own dealer
Page 125 and 126: Rules and Regulations Many rules re
Page 129 and 130: One of the assets specifically iden
Page 131 and 132: Where a covenant may be enforced it
Page 135 and 136: 1. Spread income over a number of y
Page 137 and 138: RELATED FINANCE COMPANY CHECKSHEET
Page 141 and 142: 3. Question the taxpayer directly w
Page 145 and 146: Technicalities Under the provisions
Page 149 and 150: Cash 300 Accounts Receivable 300 2.
Page 151 and 152: The dealer sells the note to a fina
Page 153 and 154: For purposes of this rule, an "empl
Page 155 and 156: 10) relationship of stockholder-off
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purely for services. See Treas. Reg
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Howard Sole, Inc. v. Commissioner,
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Milford Motor Co. v. United States,
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new pool for additional, subsequent
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6. The finance company is entitled
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when the back-end distributions are
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The transfer of the installment con
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Report as a Loan or an Assignment
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Reported as a Sale… (How it Shoul
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Other Sources of Information IRC se
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Part 4 Appendices Appendix A Initia
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2) Adjusting Journal Entries 3) Tax
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k. Do you receive rebates from anyo
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f. Employee Benefits 1) Form 5500?
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Appendix B Balance Sheet Section -
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. Dealership financing If the deale
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f. Dealer Reserve Holdbacks 3. Inve
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Once the existence of a shareholder
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Despite the fact the computation ma
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corporate minutes if material. d. L
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Appendix C Definition of an Item Co
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two cars of the same model can vary
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Appendix D An Analysis of the Wrigh
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(D) also moved (DLRS) income to be
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The court did not allow (D)’s cla
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Appendix E Glossary The following t
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FIFO: An inventory cost flow assump
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PLATFORM: A vehicle platform is the
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Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

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