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

Rules and Regulations
Many rules regarding the treatment of advertising amounts on both the manufacturer and
dealership level exist as brought out by Revenue Rulings, Court cases, Internal Revenue Code
sections and Treasury Regulations. The current rules are paraphrased below:
1. IRC section 446(b): If the way the taxpayer is treating the income/expense relating to the
advertising association distorts income, a new method that does not distort income can be
employed.
2. IRC section 481(a): Prior period adjustments resulting from a change in accounting method
should be used to compute the open year deficiency. Also see the chapter on Extended
Service Contracts in this Guide.
3. IRC section 7701(a)(3): For Internal Revenue Code purposes, the term "corporation" includes
associations and joint-stock companies.
4. Rev. Rul. 74-318: Where an advertising association has discretionary control in the use of the
advertising fees paid by the member dealerships and the manufacturer, amounts are includable
in gross income with ordinary deductions allowable.
5. Rev. Rul. 74-319: An advertising fund established by franchise dealers, administered under a
written contract by the manufacturer who receives and bills non-refundable fees, spends the
accumulated funds on national advertising only (for the dealer’s benefit), accounts for the
funds separately in the books, and carries yearend balances as a liability to the dealers, is an
association taxable as a corporation.
6. Treas. Reg. section 1.461-4(d)(2): Advertising fees are deductible when economic
performance occurs, i.e., when the money is spent on advertising. See the chapter on
Extended Service Contracts in this Guide.
7. Association expenses are deductible after applying the rules of IRC section 277 which requires
the division of items into member versus non-member categorization, i.e., portfolio income is
reported and taxed.
8. The dealership can expense amounts paid to the manufacturer for advertising, if the amount is
listed on the invoice, given to a local ad association for the sole purpose of advertising and the
excess is refunded to next years charges.
Under current law, if the dealership does not include the advertising fee in the cost of the vehicle
and the amount is not listed on the invoice then the agent is correct in applying Treas. Reg.
section 1.461-4(d)(7), Example 5 and Treas. Reg. section 1.461-4(g) by adhering to the economic
performance occurrence theory. Taxable income is recomputed giving an expense when and
where monies are paid or owed to bona fide advertising media. Additionally, where reserves exist
that are not truly restricted from the use of the shareholders, the reserves should be recaptured
into current year income and considered a constructed dividend.
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