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

includable in the gross income of the dealer, but merely represent a reduction of the accounts
receivable representing the amount due from the manufacturer for warranty work performed.
1. Law
IRC section 446(a) provides, in pertinent part, that taxable income shall be computed under
the method of accounting on the basis of which the taxpayer regularly computes his income in
keeping his books.
IRC section 451 provides that the amount of any item of gross income shall be included in
gross income for the taxable year in which received by the taxpayer, unless, under the method
of accounting used in computing taxable income, such amount is to be accounted for as of a
different period.
2. Rev. Rul. 72-595
The amounts represented by the credit memorandum issued by the manufacturer are not
includable in the gross income of the dealer, but merely represent a reduction of the dealer’s
accounts receivable for amounts due from the manufacturer for warranty work performed.
Finance Reserves
One income issue found in new car dealerships has to do with the manner in which Finance
Income is reported. When dealerships sell cars, they also typically arrange financing for the buyer.
These finance contracts are usually sold to a financial institution and the dealership typically
participates in the income derived from these contracts. The amount of income depends on a
pre-arrangement with the financial institution where the dealership earns a greater amount if the
financing is more lucrative.
Ordinarily, the financial institution and the dealership establish an account called a "Dealer
Reserve Account" that is credited, with the dealership’s "commission" for arranging financing for
the buyer, when the financing company determines the income allocation. This account may also
be charged (reduced) when a contract with recourse to the dealership defaults. In most instances
the financial institution holds part of the dealer’s reserve to cover contingent events (i.e. in the
event the note is prepaid early or the car is repossessed).
1. Example
A dealer sells a car to a customer for the following:
Sales Price (including Sales Tax and license fees) $10,000
Less: Down payment 1,000
Balance to be Financed $ 9,000
Finance Charge @ 10 percent 900
Face amount of Installment Note $ 9,900
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