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

4. Agent development of issue
a. Obtain documentation of salaries and wages (paid and accrued) for the managers of the
various departments by inspection of the Forms W-2 and the payroll registers. Yearend
bonuses are reflected as accrued salaries and a detail of the employees would reflect
amounts paid to the managers.
b. Through a review of the corporate minutes and the minutes of the board of directors
meetings for the authorization of salaries and bonuses, the agent can determine the
formality and timing of the corporate actions. The minutes may also reveal the method of
determining salaries and bonuses (i.e., a formula), economic and financial concerns of the
corporation, and the dividend history of the corporation.
c. Dividends paid during the current year should be reflected on the schedule M-2 of the tax
return and as a reduction to the retained earnings account.
d. Review of prior year tax returns (4 years) would indicate whether the officers had been
underpaid in prior years and establish a salary history for the officers.
e. Examine the travel and entertainment expense with the intent of scheduling the
officer/shareholder’s activities (business and non-business) throughout the year.
f. The Dealership Franchise Agreement may provide information as to working capital
agreements ("Minimum Capital Standard Agreements") and identify certain key employees
of the dealership (i.e., president, general managers and shareholders).
g. Other factors concerning the officer-shareholder that need to be developed are:
1) Specific qualification of the employee (i.e., educational level, experience).
2) Salary history of the individual (i.e., increased salary and corresponding changes in
responsibility or productivity).
3) Contribution(s) of the officer-shareholder to the success of the business; growth of
the business.
4) Comparison of officer’s salaries with other comparable dealerships in the industry.
5) Economic conditions of the automobile industry and of the nation as a whole.
5. Legal Authority
IRC section 162(a)(1) allows a deduction for all ordinary and necessary expenses paid or
incurred during a taxable year in carrying on a trade or business, including a reasonable
allowance for salaries or other compensation for personal services actually rendered. To be
deductible, salaries and bonuses must be both reasonable in amount and in fact payments
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