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

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1. Averaging Within Submodels Corolla 1985 1986 1702 5,967 6,319 50,941 / 48,956 = 1.041 1703 6,285 6,654 1712 6,190 6,543 1787 7,352 7,669 1795 7,060 7,360 1788 7,950 8,121 1798 8,155 8,275 48,959 50,941 2. Correct Submodel Cost Extension Unit 1985 1986 End Extended Extended Corolla Inv 1985 Cost 1986 Cost 1702 1 5,967 5,967 6,319 6,319 860,222 / 835,077 1703 2 6,285 12,570 6,654 13,308 = 1.030 1712 1 6,190 6,190 6,543 6,543 1787 25 7,352 183,800 7,669 191,725 1795 26 7,060 183,560 7,360 191,360 1788 27 7,950 214,650 8,121 219,267 1798 28 8,155 228,340 8,275 231,700 110 835,077 860,222 The preceding example of "Averaging Within Submodels" does not consider actual numbers of units in ending inventory, but only considers the average of specific submodel ranges. The "Correct Submodel Extension" example considers items in ending inventory. Consider an ending inventory of $2 million. A dealership with only 200 vehicles in ending inventory with a value of $10,000 each would have a $2,000,000 inventory. The difference between application of an index of 1.04 and 1.03 to this inventory is $20,000. ($2,000,000 x 1.04 is 2,080,000; $2,000,000 x 1.03 is $2,060,000.) As an addition to the reserve this would produce an unwarranted deferral of the tax on $20,000. As a decrease to gross profit this would produce an unwarranted $20,000 cost of goods sold deduction. This example was rather basic and involved only one sub model group. In practice, the distortion produced by averaging within many sub model groups becomes increasingly material with higher unwarranted indices. The second manner in which some dealers were distorting income was by comparing newly introduced models to existing items. A new vehicle has no item which proceeded it to which a comparison in measuring years could be made to determine inflation. Therefore, a new vehicle should receive no inflation or an index of 1.000. Another issue was that some dealers did not construct the cost of a new vehicle as required by the regulations. The distortion of income would occur because new items entering inventory were receiving 7-4
improper inflation through unwarranted "reconstructions" of supposed like kind vehicles. In some cases, there was no vehicle that previously existed which could be compared to a new vehicle. Recall the Suzuki Samurai as an example where no vehicle which preceded it could be compared. Such improper comparisons known as "reconstructions" would produce unwarranted higher indices, thus a higher unwarranted deferral in the reserve and an unwarranted increased annual cost of goods sold deduction. There were other problems. The one concerned a lack of adequate record retention. Some dealers were not maintaining records, as mandated by the regulations, which would enable the Service to determine the level of dealership compliance. An additional problem concerning the computation of option indices was encountered. The Link Chain Method envisions accounting for each item in ending inventory. Once the items in ending inventory are determined, each item needs to be priced and inflation assigned to it. LIFO contemplates two methods of costing or pricing items in ending inventory. One of these pricing methods would be elected on the dealers Form 970. Pricing entails going back 1 year under the Latest Acquisitions Method or 2 years under the Earliest Acquisitions Method. Application of these methods of costing encompasses the following analysis. If there were 300 vehicles in ending inventory for a particular year, those invoices needed to be secured. It is not uncommon for a midsized dealership to have this volume in ending inventory. Then the invoices were scheduled and a determination was made they represent the items in ending inventory. Once this was done, each vehicle was listed showing the current year price and the price for this same item in the preceding year or years, if it was in existence. Doing this with 300 vehicles was cumbersome, but workable. Such was not the case concerning options. Some domestic vehicles listed almost everything as an option. It was not uncommon for the invoices associated with these domestic vehicles to have 10, or more, options per vehicle. Each option needed specific pricing for the necessary measuring years, just as the vehicles did. Foreign vehicles were better, but not much. Invoices utilized for a particular manufacturer at this time showed about 5 options per vehicle. The domestic vehicles and associated options for the ending inventory cited above would require individualized accounting and pricing for approximately 3,300 items for each year of the LIFO election using the Latest Acquisitions Method. The number of accounting and pricing requirements would double if the Earliest Acquisitions Method was used. The foreign vehicles cited above would require pricing for approximately 1,800 items under the Latest Acquisitions Method and 3,600 under the Earliest Acquisitions Method for each year of the LIFO election. Some of the cases being worked at this time had 10 years or more of LIFO indices that required individualized accounting and pricing of each item in those ending inventories. Statistical sampling was contemplated, but deemed not appropriate for two reasons. First, the pure Link Chain Method contemplated actual pricing of each item in ending inventory. Second, the dealers would not allow the Service to perform a statistical sample, although many used one themselves. They wanted the Service to price every item if their indices were going to be challenged knowing this was very difficult, if not impractical. 7-5
Page 1 and 2: Internal Revenue Service Market Seg
Page 3 and 4: Preface One of the goals envisioned
Page 5 and 6: Table of Contents Preface .........
Page 7 and 8: The Reinsurance Transaction .......
Page 9 and 10: Part 1 General Focus and Procedure
Page 11 and 12: 1. Type A Return Information Schedu
Page 13 and 14: Percentage has gone down. The incre
Page 15 and 16: the principal shareholders to finan
Page 17 and 18: Rents $ 500,000 Interest $ 50,000 C
Page 19 and 20: Conclusion "Financial status" is on
Page 21 and 22: Chapter 2 Getting Started The key t
Page 23 and 24: entities and their purpose and rela
Page 25 and 26: It is recommended that officer comp
Page 27 and 28: Chapter 3 Standard Audit Index Numb
Page 29 and 30: Chapter 4 Books and Records Charact
Page 31 and 32: c. Reconcile (2): Beginning Trial B
Page 33 and 34: 3 Repair Order Sales 4 Parts Sales
Page 35 and 36: Conclusion Although intimidating at
Page 37 and 38: Chapter 5 Balance Sheet Why do we c
Page 39 and 40: When an adjustment to a balance she
Page 41 and 42: Part 2 Inventory Chapter 6 General
Page 43 and 44: . Purchasing c. Handling, processin
Page 45 and 46: dealerships use specific identifica
Page 47 and 48: Chapter 7 LIFO Background Overview
Page 49: A Short History of LIFO Application
Page 53 and 54: Introduction Chapter 8 Computing LI
Page 55 and 56: The double extension index formula
Page 57 and 58: as one item, there would probably n
Page 59 and 60: (existing items) and non-comparable
Page 61 and 62: The current-year costs that can be
Page 63 and 64: Assuming the dealership elects LIFO
Page 65 and 66: matching of revenues and costs. Thu
Page 67 and 68: section 1.471-9. Both of these regu
Page 69 and 70: providing to the credit subsidiary
Page 71 and 72: Under elections made prior to Decem
Page 73 and 74: Base Year Cost 9112 $224,000 You ha
Page 75 and 76: BLS Sanity Check A simpler means to
Page 77 and 78: CYC = Current Year Cost. This is th
Page 79 and 80: Computation of 1993 Increment and R
Page 81 and 82: This page intentionally left blank.
Page 83 and 84: Specific Identification Increment M
Page 85 and 86: which may be identified by a unique
Page 87 and 88: Step # 3 For each item category, ad
Page 89 and 90: Step # 10 Compute the total cost of
Page 91 and 92: 1991 Inventory Value at Current Yea
Page 95 and 96: Dealers may offer the contracts as
Page 99 and 100: 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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This page intentionally left blank.
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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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For purposes of this rule, an "empl
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10) relationship of stockholder-off
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purely for services. See Treas. Reg
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Howard Sole, Inc. v. Commissioner,
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Milford Motor Co. v. United States,
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new pool for additional, subsequent
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6. The finance company is entitled
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when the back-end distributions are
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The transfer of the installment con
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Report as a Loan or an Assignment
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Reported as a Sale… (How it Shoul
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Other Sources of Information IRC se
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Part 4 Appendices Appendix A Initia
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2) Adjusting Journal Entries 3) Tax
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k. Do you receive rebates from anyo
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f. Employee Benefits 1) Form 5500?
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Appendix B Balance Sheet Section -
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. Dealership financing If the deale
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f. Dealer Reserve Holdbacks 3. Inve
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Once the existence of a shareholder
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Despite the fact the computation ma
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corporate minutes if material. d. L
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Appendix C Definition of an Item Co
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two cars of the same model can vary
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Appendix D An Analysis of the Wrigh
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(D) also moved (DLRS) income to be
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The court did not allow (D)’s cla
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Appendix E Glossary The following t
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FIFO: An inventory cost flow assump
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PLATFORM: A vehicle platform is the
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