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

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Chapter 11 Extended Service Contracts Dealerships frequently offer extended service contracts to their customers in connection with the sale of a vehicle. Extended service contracts provide for repairs to covered vehicle components during a designated term. The dealership often sells more than one type or brand of service contract and may be either the "principal" / "obligor" or an "agent." If the dealer is an agent of the administrator, insurer, or other party, the contract will contain language that indicates that the contract is between the vehicle purchaser and the other party, not the dealership. The contract administrator may also be named in the contract. If the dealer is the principal, the contract will contain language indicating that the contract is between the dealer and the vehicle purchaser. The contract may also contain language indicating the administrator and the party that insures that dealer’s interest. In addition to the vehicle service contract, other documents are important to the extended service contract program. Other documents include an administrator agreement and an insurance policy. Regardless of whether the dealer acts as an agent or the extended service contract is a dealer obligor plan, the administrator generally provides the vehicle service contract documents. All contracts related to the service contract plan must be examined too determine whether a dealership is an agent or principal. Proper tax treatment of extended service contracts depends on an accurate determination of who is obligated under the contract. Agent versus Principal/Obligor A dealer can market aftersale products as either an agent or as a principal. Dealers sometimes attempt to structure these transactions so they will be classified as agents due to the favorable tax treatment. What an agent or principal/obligor is in the context of the sale of extended service contracts can be loosely defined as follows: 1. Agent An agent is one who sells the products of a third party insurer without assuming the legal obligations or insurance risk of the product sold. The agent receives a fee for the sale and necessary administrative services rendered. The activities of an agent are not strictly limited to sales of insurance. In the past, some dealerships were selling factory extended "warranties" as agents for a product that was not then considered by the parties to be an "insurance" product. 11-1
2. Principal/Obligor A principal is a party to the contract who assumes the risk contemplated in the contract, is directly responsible for any ensuing liabilities that may arise and derives compensation from the profit built into the product sold. The principal in the automobile context will generally insure the obligations undertaken in these contracts with a third party insurer, but remains the primary obligor to the consumer. As a principal/obligor, dealers should include in income the full amount received from the consumer for the mechanical breakdown contract. The amount remitted for the insurance premium should then be amortized over the term of the contract. Dealer "Agent" Extended Service Contracts If the extended service contract is between the vehicle purchaser and an administrator, insurance company or other party, the dealership acts as an agent and earns a commission. Generally, the dealership determines the selling price of the extended service contract and forwards a portion to the administrator based on a "cost schedule." The commission income must be accrued when the contract is sold. The commission amount is the difference between the extended service contract selling price and the amount the dealer forwards to the administrator, insurance company, or other party. Dealer "Obligor" Extended Service Contract When the extended service contract is between the vehicle purchaser and the dealership, the dealership is the "obligor" or "principal" on the contract. When a dealership acts as obligor or principal, it may purchase an insurance policy that insures its liability under the service contract. Thus, there are two transactions: one between the dealer and the customer, and the second between the dealer and an insurance company. Dealerships that sell dealer obligor contracts and purchase insurance to cover their risks often report the income in a manner similar to a dealer agent contract, i.e. report only the commission income. To properly account for a dealer obligor contract, the dealership must include in income the entire sales price of the service contract. Generally, taxpayers that determine their taxable income using the accrual method of accounting must include advance payments in income when received. The Supreme Court applied this rule in Automobile Club v. Commissioner, 353 U.S. 180 (1957) to membership dues collected 1 year in advance. The rule was also applied to service contracts in Streight Radio and Television, Inc. v. Commissioner, 280 F.2d 883 (7th Cir. 1960) where the taxpayer had unrestricted use of the funds. Rev. Proc. 71-21, 71-2 C.B. Page 549 provides for an election to defer advance payments for services where the services are to be performed by the end of the next tax year. 11-2
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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
Page 47 and 48: Chapter 7 LIFO Background Overview
Page 49 and 50: A Short History of LIFO Application
Page 51 and 52: improper inflation through unwarran
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
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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
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Page 101 and 102: Rev. Proc. 97-38 provided for an al
Page 103 and 104: Contract Construction Generally, a
Page 105 and 106: Rev. Proc. 97-27 provides the admin
Page 107 and 108: The Court ruled that when the deale
Page 109 and 110: Considerations for Forming a Produc
Page 111 and 112: The Reinsurance Transaction To illu
Page 113 and 114: insurance contract reinsured throug
Page 115 and 116: (1979). The Service’s position is
Page 117 and 118: While not all captive situations in
Page 119 and 120: 3. IRC section 845 tax avoidance 4.
Page 121 and 122: section, seemingly compliant arrang
Page 123 and 124: 2. By owner A dealer may own dealer
Page 125 and 126: Rules and Regulations Many rules re
Page 129 and 130: One of the assets specifically iden
Page 131 and 132: Where a covenant may be enforced it
Page 135 and 136: 1. Spread income over a number of y
Page 137 and 138: RELATED FINANCE COMPANY CHECKSHEET
Page 141 and 142: 3. Question the taxpayer directly w
Page 145 and 146: 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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Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

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