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

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The court laid out a simple, but potent rule as the governing principle in this case: Money diverted to a sham is taxable to the true owner. The court held that the corporate form of (FIR) should be disregarded and the income of (FIR) should be deemed received by (D). The court felt (D) was engaged in sham transactions. The court cited several factors concluding the transactions lacked economic substance: a. Reduction of Commissions - This served no normal business purpose. The activity wrongfully reduced (DLRS) taxable income and improperly allocated income to (FIR). b. "Over-submits" - (D) knew (FIR) did nothing to earn this income. (D) knew this arrangement was risky for tax purposes. The court felt (D) knew these overpayments constituted a large portion of the "principal" for his retirement plan, and as constituted, over inflated (DLRS) expenses; wrongfully allocating income to (FIR). c. The insurance contracts do not demonstrate any risk shifting or distribution. The court felt the agreements constituted a captive insurance arrangement. The dealership who took out the $500,000 letter of credit makes that related corporation, not the offshore reinsurance company, at risk in the insurance arrangement. There is no unrelated business. d. The carelessness in which (FIR) was formed denotes a sham insurance relationship. The court specifically cited, among other factors; organizing offshore to escape regulation, lack of capitalization, the erroneous and undocumented computation of reserves shows a disregard for standard insurance practices. Additionally, modifications were not entered into, and the $500,000 letter of credit from (DLR) to establish mandated "reserves" were cited. e. The court did not address the issue of constructive dividends because all income was allocated to (D). The court felt the interest earned by the annuities was taxable to (D). There was no risk shifting involved. The intent of the arrangement was to use the annuity interest to pay claims and to forward the principal to (D) upon termination of all service contracts. The annuities, in essence, were self-insurance reserves and the evidence shows they were owned by (D). 4. Reasonable Compensation Concerning the reasonable compensation question, the issue was basically one of compensation versus dividend. The court sustained the government’s disallowance of (D)’s compensation as an expense stating (D) did not establish his formula for determining compensation was valid. D-4
The court did not allow (D)’s claim for estimated warranty expense for subsequent years because he did not establish that he was entitled to it. The only offer of proof was a completed income tax return. The court sustained the negligence, fraud, and substantial understatement penalties as they applied to the reallocation of income. Whenever a revenue agent encounters a PORC they should review the Wright case which held: income wrongfully diverted to an offshore reinsurance company is allocated to the (sole) controlling shareholder where he engages in sham transactions, and the corporate form of the offshore company is disregarded. D-5
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Internal Revenue Service Market Seg
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Preface One of the goals envisioned
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Table of Contents Preface .........
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The Reinsurance Transaction .......
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Part 1 General Focus and Procedure
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1. Type A Return Information Schedu
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Percentage has gone down. The incre
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the principal shareholders to finan
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Rents $ 500,000 Interest $ 50,000 C
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Conclusion "Financial status" is on
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Chapter 2 Getting Started The key t
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entities and their purpose and rela
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It is recommended that officer comp
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Chapter 3 Standard Audit Index Numb
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Chapter 4 Books and Records Charact
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c. Reconcile (2): Beginning Trial B
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3 Repair Order Sales 4 Parts Sales
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Conclusion Although intimidating at
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Chapter 5 Balance Sheet Why do we c
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When an adjustment to a balance she
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Part 2 Inventory Chapter 6 General
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. Purchasing c. Handling, processin
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dealerships use specific identifica
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Chapter 7 LIFO Background Overview
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A Short History of LIFO Application
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improper inflation through unwarran
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Introduction Chapter 8 Computing LI
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The double extension index formula
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as one item, there would probably n
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(existing items) and non-comparable
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The current-year costs that can be
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Assuming the dealership elects LIFO
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matching of revenues and costs. Thu
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section 1.471-9. Both of these regu
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providing to the credit subsidiary
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Under elections made prior to Decem
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Base Year Cost 9112 $224,000 You ha
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BLS Sanity Check A simpler means to
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CYC = Current Year Cost. This is th
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Computation of 1993 Increment and R
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Specific Identification Increment M
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which may be identified by a unique
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Step # 3 For each item category, ad
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Step # 10 Compute the total cost of
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1991 Inventory Value at Current Yea
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Dealers may offer the contracts as
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2. Principal/Obligor A principal is
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Rev. Proc. 97-38 provided for an al
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Contract Construction Generally, a
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Rev. Proc. 97-27 provides the admin
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The Court ruled that when the deale
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Considerations for Forming a Produc
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The Reinsurance Transaction To illu
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insurance contract reinsured throug
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(1979). The Service’s position is
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While not all captive situations in
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3. IRC section 845 tax avoidance 4.
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section, seemingly compliant arrang
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2. By owner A dealer may own dealer
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Rules and Regulations Many rules re
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One of the assets specifically iden
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Where a covenant may be enforced it
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1. Spread income over a number of y
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RELATED FINANCE COMPANY CHECKSHEET
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3. Question the taxpayer directly w
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Technicalities Under the provisions
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Cash 300 Accounts Receivable 300 2.
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The dealer sells the note to a fina
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Page 155 and 156: 10) relationship of stockholder-off
Page 157 and 158: purely for services. See Treas. Reg
Page 159 and 160: Howard Sole, Inc. v. Commissioner,
Page 161 and 162: Milford Motor Co. v. United States,
Page 163 and 164: new pool for additional, subsequent
Page 165 and 166: 6. The finance company is entitled
Page 167 and 168: when the back-end distributions are
Page 169 and 170: The transfer of the installment con
Page 171 and 172: Report as a Loan or an Assignment
Page 173 and 174: Reported as a Sale… (How it Shoul
Page 175 and 176: Other Sources of Information IRC se
Page 177 and 178: Part 4 Appendices Appendix A Initia
Page 179 and 180: 2) Adjusting Journal Entries 3) Tax
Page 181 and 182: k. Do you receive rebates from anyo
Page 183 and 184: f. Employee Benefits 1) Form 5500?
Page 185 and 186: Appendix B Balance Sheet Section -
Page 187 and 188: . Dealership financing If the deale
Page 189 and 190: f. Dealer Reserve Holdbacks 3. Inve
Page 191 and 192: Once the existence of a shareholder
Page 193 and 194: Despite the fact the computation ma
Page 195 and 196: corporate minutes if material. d. L
Page 197 and 198: Appendix C Definition of an Item Co
Page 199 and 200: two cars of the same model can vary
Page 201 and 202: Appendix D An Analysis of the Wrigh
Page 203: (D) also moved (DLRS) income to be
Page 207 and 208: Appendix E Glossary The following t
Page 209 and 210: FIFO: An inventory cost flow assump
Page 211: PLATFORM: A vehicle platform is the
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Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

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