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

and the "general" method are generally available to dealers. The other two are available only
in limited circumstances.
Unreasonable Compensation
Most auto dealerships are closely held corporations with one to two shareholders. In addition to
being a closely held corporation, the majority shareholder will often spin-off operations of the
dealership and form other related entities. The existence of multiple corporations may create a
situation in which compensation may be split between two or more related corporations, and
which in the aggregate, may be considered excessive.
The general manager (sometimes, the minority shareholder), is the person who runs the
day-to-day operations of the dealership. His/Her duties may include: hiring, training, promoting
and supervising personnel; maintaining relations with the manufacturer; developing advertising
policy and writing and placing advertising copy; establishing lines of credit and flooring
arrangements. However, in most cases the majority shareholder/president of the dealership is the
highest compensated employee. Sometimes, the majority shareholder is also involved in other
business activities such as other dealerships. If this is the case, the total time devoted to each of
the businesses compared to the total amount of compensation paid by all entities should be
considered in determining the reasonableness of the compensation. The agent should also be
aware that pension contributions are a form of compensation and should be considered in
determining whether the amounts deducted as compensation are reasonable.
It is customary for automobile dealerships to pay top management employees incentive bonuses
based on a percentage of net profits in addition to their basic monthly salaries, regardless of
whether such employees own stock in the dealership. Often the officers and other key employees
are paid relatively modest salaries which are augmented by the aforementioned bonuses. See
Good Chevrolet v. Commissioner, T.C. Memo. 1977-291, CCH 34,606(M).
1. Reasonableness of Compensation
a. IRM Factors
The Internal Revenue Manual list the following factors to be considered in deciding
whether compensation is reasonable [See the current IRM]:
1) nature of duties,
2) background and experience,
3) knowledge of the business,
4) size of the business,
5) individual’s contribution to profit making,
6) time devoted,
7) economic conditions in general, and locally,
8) character and amount of responsibility,
9) time of year compensation is determined,
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