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

Percentage has gone down. The increase to cost of sales and decrease to expense is curious.
It will be necessary to determine which sub-accounts comprise the Cost of Sales Tax Account.
These items should be a focus of questioning during the initial interview.
Type B Analysis
In addition to the Type A analytical tools, it may be prudent to examine a taxpayer who is
involved in primarily one large controlled entity along broader and more encompassing guidelines.
The Type B analysis focuses upon one, two or a few entities created for the benefit of the auto
dealer.
Looking at only one tax return may be deceiving. Taxpayers involved with only one real business
often form other entities "in order to clarify operations and distinguish activities." However, these
additional entities can give some taxpayer flexibility to devise improper tax avoidance schemes
that would not be possible without the additional entity layer and are difficult to detect because of
it.
New auto dealerships maintain good internal controls and prepare complete books and records.
Dealerships, as franchisees, properly book sales activities to conform with the financial statement
requirements imposed in the form of the manufacturers statements by the franchisor, the factory.
Once the income is booked some dealerships may incorrectly treat or classify them for tax
purposes. Often this may occur through means of unnecessary shifting of business activities to the
aforementioned related entities.
An entity chart is helpful in getting the big picture. It is important that all related returns are
gathered. The one the agent may miss may be the one that sheds a great deal of light on the
reality represented in these tax returns. It is possible that a separate entity will be established to
hold the land owned by the shareholder and "rented" to the dealership as its operating site. An
"insurance company" may be formed to "facilitate the paper flow" of extended service contract
sales or a "management company" is formed to receive management fees that may represent
potential unreasonable compensation. These are some of the related entities created by some auto
dealers that need to be identified and understood by the revenue agent.
Again, the Cash T and a comparative analysis are necessary to make the Type B analysis, once
these related entities have been identified. An obvious increase in costs without related increases
in revenues indicates either a troubled market, where one would expect to see dealers exit, or a
troubled tax return, where one would expect to see areas to be addressed through an audit.
Additionally, regression analysis may be applied to forecast the taxpayer’s subsequent year’s
position.
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