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

that the advances had no fixed maturity date, and that the reinsurance company had demanded
repayment on only two occasions. The judge determined that the reinsurance company was
formed "to provide the shareholder with tax-free and interest-free access to profits attributable to
policies issued through the shareholder’s dealership."
Finally, the Court addressed a reinsurance company and supported the imposition of the fraud
penalty in William T. Wright, T.C. Memo 1993-328. The Court agreed with the Service and
characterized the transactions between the Wright dealerships and William Wright’s reinsurance
insurance company as sham transactions. The corporate form of the captive insurance company
was disregarded and its income deemed received by Wright.
PORC issues are complex and require a thorough analysis of all documents and transactions.
Depending on the facts and circumstances of each case, the amount paid as insurance premiums
by the automobile dealership to the fronting company are not deductible under IRC section 162.
The amounts ultimately remain under the practical control of the dealer who retains an economic
stake in whether a covered loss occurs. The amounts paid as fees to the fronting company are
deductible by the dealership based upon the principles of economic performance.
Since the amounts paid are not insurance premiums, the provisions of Rev. Procs. 92-97 and
97-38 do not apply.
The amounts received from customers for extended service contracts are income in the year the
service contracts are sold by the dealership.
The dealership is entitled to a deduction under IRC section 165(a) for any losses sustained in
connection with the extended service contracts during the taxable year.
The reinsurance company does not qualify as an insurance company for Federal income tax
purposes.
All funds distributed to the shareholders by the reinsurance company are to be treated as
distributions by the dealership(s) to its/their owner(s).
The Captive Transaction
Captive Insurance Arrangements
Some industry personnel believe captive insurance applies to PORC. IRC section 162(a) permits
a taxpayer to deduct its ordinary and necessary expenses paid or incurred during the taxable year
in carrying on a trade or business. Treas. Reg. section 1.162-1(a) provides that allowable
business expenses include premiums paid to insure against losses from fire, storm, theft, accident
or similar losses suffered by a business. A corporation is not entitled to deduct amounts set aside
in a self-insurance reserve to protect against potential losses. Spring Canyon Coal Co. v.
Commissioner, 13 B.T.A. 189 (1928), aff’d, 43 F.2d 78 (10th Cir. 1930), cert. denied, 284 U.S.
654 (1931). See Commissioner v. Lincoln Savings and Loan Assn., 403 U.S. 345 (1971), and
Steere Tank Lines, Inc. v. United States, 577 F.2d 279 (5th Cir. 1978), cert. denied, 440 U.S. 946
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