This chapter discusses three
main segments: income issues,
compensation issues and other
miscellaneous issues. The topics
updated and/or added are:
compensation issues: service
tech tools, manufacturer's
incentive, shuttlers' income
issues; auto demonstrator
vehicles, other miscellaneous:
Cores, used car donation
programs; a new credit for
electric cars; hybrid vehicles;
cost segregation and
cancellation of dealership
franchises.
1.
SERVICE TECHNICIAN TOOL
REIMBURSEMENTS
The Motor Vehicle Technical
Advisor, under the Pre Filing &
Technical division of Large and
Midsize Business Division (LMSB)
Retail Industry finalized the
following Coordinated Issue,
dated July 21, 2000.
ISSUE: Whether
amounts paid to motor
vehicle service technicians
as reimbursements for the
use of the technicians'
tools are paid under an
accountable plan?
CONCLUSION:
Generally, amounts paid to
motor vehicle service
technicians (service techs)
as tool reimbursements not
meet the accountable plan
requirements. Amounts paid
under an unaccountable plan
are included in the
employee' s gross income,
must be reported to the
employee on Form W-2 and are
subject to the withholding
and payment of federal
employment taxes.
FACTS
Motor vehicle service
technicians (service techs) are
hired as employees by
dealerships, repair and body
shops, and various other
enterprises to perform repair
and maintenance services on
vehicles. As a condition of
employment, service techs are
required to provide and maintain
their own tools, which are kept
on-site at the business
locations. Generally, the tools
are used exclusively by the
technician to whom they belong.
Service techs are paid hourly
wages.
Instead of paying an hourly wage
for the performance of services,
many employers bifurcate the
hourly wage paid to the service
techs into "wages" and "tool
reimbursements". These plans
purport to fall under the aegis
of accountable plans as
described in Internal Revenue
Code (the Code) section 62 and
the regulations thereunder.
Under I.R.C. § 62(c)
reimbursements for employee
business expenses meeting
certain requirements are not
wages includible in income or
subject to the withholding and
payment of employment taxes.
These plans may be administered
either by a third party for a
fee or by the employer.
In a typical arrangement, the
hourly wage paid to the service
tech is divided into a wage
portion and a tool reimbursement
portion. Income and employment
taxes are withheld and paid on
the wages, but no income or
employment taxes are withheld on
the tool reimbursement.
Employers use various methods to
determine the amount paid as
tool reimbursement. For example,
the method used might measure
the hourly value of the tools
the service tech owns multiplied
by the number of hours the
service tech worked.
The method may consider the type
of tool, its useful life,
original cost or replacement
value, geographic location of
the worker and other factors.
Alternatively, service techs
could be paid a tool allowance
or advance not based upon the
value of the tools or the
expenses incurred in use. None
of the methods, however, are
directly correlated with or
based exclusively upon the
actual expenses paid or incurred
by the service technician for
tools. In a typical arrangement
amounts paid as tool
reimbursements are not reported
on Form W-2, but are sometimes
reported on Form 1099.
PPLICABLE LAW
Wages
In general, wages are defined
for Federal Insurance
Contributions Act (FICA),
Federal Unemployment Tax Act
(FUTA) and income tax
withholding purposes as all
remuneration for employment
unless otherwise excluded.
I.R.C. §§ 3121(a), 3306(b) and
3401(a). There is no statutory
exception from wages for amounts
paid by employers to employees
for employee business expenses.
However, Treasury reg.
§1.62-2(c)(4) provides that
amounts an employer pays to an
employee for employee business
expenses under an "accountable
plan" are excluded from the
employee's gross income, are not
required to be reported on the
employee's Form W-2, and are
exempt from the withholding and
payment of employment taxes.
Treas. reg. §§ 31.3121 (a)-3,
31.3306(b)-2, and 31.3401(a)-4
of the Employment Tax
Regulations, and Treas. reg. §
1.6041-3(h)(1) of the Income Tax
Regulations.
Accountable Plan
Whether amounts are paid under
an accountable plan is governed
by I.R.C. § 62, which includes
the provisions on employee
reimbursement or other expense
allowance arrangements. Section
62 generally defines "adjusted
gross income" as gross income
minus certain ("above-the-line")
deductions. Section 62(a)(2)(A)
allows an employee an
above-the-line deduction for
expenses paid by the employee,
in connection with his or her
performance of services as an
employee, under a reimbursement
or other expense allowance
arrangement with the employer.
Section 62(c) provides that an
arrangement will not be treated
as a reimbursement or other
expense allowance arrangement
for purposes of I.R.C. §
62(a)(2)(A) if (1) such
arrangement does not require the
employee to substantiate the
expenses covered by the
arrangement to the person
providing the reimbursement or
(2) such arrangement provides
the employee with the right to
retain any amount in excess of
the substantiated expenses
covered under the arrangement.
Under § 1.62-2(c)(1) of the
regulations, a reimbursement or
other expense allowance
arrangement satisfies the
requirements of I.R.C. § 62(c)
if it meets "the three
requirements" set forth in
paragraphs (d), (e), and (f) of
Treas. reg. § 1.62-2: business
connection, substantiation, and
returning amounts in excess of
expenses.
If an arrangement meets the
three requirements, all amounts
paid under the arrangement are
treated as paid under an
accountable plan. Treas. reg. §
1.62-2(c)(2)(i). The regulations
further provide that if an
arrangement does not satisfy one
or more of the three
requirements, all amounts paid
under the arrangement are paid
under a "nonaccountable plan."
Amounts paid under a
nonaccountable plan are included
in the employee's gross income
for the taxable year, must be
reported to the employee on Form
W-2, and are subject to
withholding and payment of
employment taxes. Treas. reg. §§
1.62-2(c)(5),
31.3121(a)-3(b)(2),
31.3306(b)-2(b)(2) and
31.3401(a)-4(b)(2).
An arrangement meets the
business connection requirement
of Treas. reg. § 1.62-2(d) if it
provides advances, allowances
(including per diem allowances,
allowances for meals and
incidental expenses, and mileage
allowances), or reimbursements
for business expenses that are
allowable as deductions by Part
VI (section 161 through section
196), subchapter B, Chapter 1 of
the Code, and that are paid or
incurred by the employee in
connection with the performance
of services as an employee.
Section 1.62-2(d)(3)(i) provides
that the business connection
requirement will not be
satisfied if the payor arranges
to pay an amount to an employee
regardless of whether the
employee incurs or is reasonably
expected to incur business
expenses described in paragraphs
(d)(1) or (d)(2).
Section 1.62-2(e) of the
regulations provides that the
substantiation requirement is
met if the arrangement requires
each business expense to be
substantiated to the payor (the
employer, its agent or a third
party) within a reasonable
period of time. As for the third
requirement that amounts in
excess of expenses must be
returned to the payor, the
general rule of Treas. reg. §
1.62- 2(f) provides that this
requirement is met if the
arrangement requires the
employee to return to the payor
within a reasonable period of
time any amount paid under the
arrangement in excess of the
expenses substantiated.
Section 1.62-2(k) provides that
if a payor's reimbursement or
other expense allowance
arrangement evidences a pattern
of abuse of the rules of section
62(c) and the regulation
sections, all payments made
under the arrangement will be
treated as made under a
nonaccountable plan.
The Service has not issued any
private letter rulings or
technical advice memoranda
concerning whether a tool
reimbursement arrangement meets
the accountable plan
requirements. However, in a
recent unreported decision,
Shotgun Delivery, Inc. v. United
States, No. C 98-4835 SC
(January 20, 2000) (Appeal
pending 9th Circuit), the United
States District Court for the
Northern District of California
granted the government's motion
for summary judgment and found
that Shotgun's expense
reimbursement arrangement with
its employees was not an
accountable plan within the
meaning of I.R.C. § 62(c). The
court held that the payments
Shotgun made to its employees
were wages subject to employment
taxes.
In Shotgun, the plaintiff,
Shotgun, provided courier
services. It charged customers
an amount, called a tag rate
that was based on distance, time
required for delivery, waiting
time, and weight. The employees
used their own vehicles for
deliveries and were paid 40
percent of the tag rate. The
couriers were compensated with
two separate checks. The first
check was a "wage check," which
paid the couriers a small hourly
amount. The second check was for
"reimbursement of expenses/lease
fee" and equaled 40% of the tag
rate minus the amount paid on
the wage check. Thus, couriers
were always paid 40% of the tag
rate. The court found the
arrangement was not an
accountable plan because it
failed to meet the business
connection requirement. Under
its arrangement, the plaintiff
reimbursed its drivers
regardless of the actual miles
driven or expenses incurred. The
court concluded that "as
Shotgun's reimbursement
arrangement had no logical
correlation to actual expenses
incurred it was an abuse of
section 62(c) an was therefore a
nonaccountable plan." That same
reasoning applies to tool
reimbursements where a portion
of the service tech's hourly
wage payment is designated as a
tool reimbursement, but the
amount has no logical connection
to the expenses incurred. In the
typical tool reimbursement
arrangement the employer carves
out a portion of the worker' s
hourly wage and recasts it as
reimbursement for expenses, when
in fact the amount treated, as
reimbursement is not related the
employee's expenses.
DISCUSSION AND ANALYSIS
Employers typically claim
reliance on Rev. Rul. 68-624,
1968-2 CB 424, as authority for
designating a portion of an
employee's compensation as a
payment for the use of tools and
excluding that amount from
wages. Rev. Rul. 68-624
considers what percentage of the
total amount paid by a
corporation for the use of a
truck and the services of a
driver are allocable as wages of
the driver for FICA purposes.
The facts specify that the
corporation hires a truck and
driver to haul stone from its
quarry to its river loading dock
at a fixed amount per load and
allocates one third of the
amount paid the employee as
wages and two-thirds as payment
for the use of the truck. The
ruling holds that an allocation
of the amount paid to an
individual when the payment is
for both personal services and
the use of equipment must be
governed by the facts in each
case. If the contract of
employment does not specify a
reasonable division of the total
amount paid between wages and
equipment, a proper allocation
may be arrived at by reference
to the prevailing wage scale in
a particular locality for
similar services in operating
the same class of equipment or
the fair rental value of similar
equipment.
Although Rev. Rul. 68-624 has
not been obsolete, it should not
be relied upon to exclude tool
reimbursement payments for
service technicians from wages.
The analysis in Rev. Rul. 68-624
does not comport with current
law because it does not consider
the application of I.R.C §62(c).
Under current law, tool
reimbursements can be excluded
from wages only if paid under an
accountable plan. An employment
contract that merely allocates
compensation between wages and
tool reimbursements will not
satisfy the requirements of
I.R.C. § 62(c). To exclude
employee reimbursements or other
expense allowance payments from
wages, an employer must
establish an accountable plan.
An arrangement will qualify as
an accountable plan if it meets
the three requirements of
business connection,
substantiation, and return of
excess.
Treas. reg. § 1.62-2(d)(1)
specifies that the business
connection requirement be met
only if the arrangement provides
advances, allowances or
reimbursements for business
expenses that are allowable as
deductions and are paid or
incurred by the employee in
connection with the performance
of services as an employee of
the employer. Thus, not only
must an employee pay or incur a
deductible business expense, but
also the expense must arise in
connection with the employment.
If an employer reimburses a
deductible tool expense that the
employee paid or incurred prior
to employment, the reimbursement
arrangement does not meet the
business connection requirement.
Further, if an employer pays an
advance or allowance based on,
for example, fair tool rental
value, regardless of whether the
employee incurs (or is
reasonably expected to incur)
the type of business expenses
described above, the
reimbursement arrangement does
not meet the business connection
requirement. Since service
techs are generally required to
provide their own tools as a
condition of employment,
expenses paid or incurred in
connection with the tools would
constitute ordinary and
necessary deductible employee
business expenses if not
reimbursed. "Paid or incurred"
requires that there be an actual
expense, not fair rental value
or use or some other intangible
figure, with which the advance,
allowance or reimbursement is
associated. In the case of an
advance or allowance, the
payment by the employer may
precede the incurring or payment
of the specific expense by the
employee, assuming the
substantiation requirements are
met in a timely manner.
Treas. Reg. § 1.62-2(e)(1)
requires that each business
expense be substantiated to the
payor within a reasonable period
of time. Treas. reg. §
1.62-2(g)(1) indicates that, in
general, the determination of a
reasonable period of time will
depend on the facts and
circumstances; however, Treas.
reg. § 1.62-2(g)(2) provides a
safe harbor allowing an advance
to be made within 30 days of an
expense, substantiation of paid
or incurred expenses within 60
days, and the return of excess
reimbursements within 120 days
of payment or incurring. It is
clear from these regulations
that an advance or allowance is
not intended to be open-ended or
unassociated with specific,
otherwise deductible, expenses.
Amounts paid by the employer not
representing specific expenses
that are actually incurred by
the employee fail to meet the
terms of an accountable plan and
are considered wages.
In addition to the requirement
that substantiation be made on a
timely basis, such
substantiation of expenses must
be detailed and complete. Treas.
reg. § 1.62-2(e)(2) requires
that, for expenses governed by
I.R.C. § 274(d), the employee
must submit information
sufficient to satisfy the
requirements of I.R.C. § 274(d)
and the regulations, which deal
with substantiating the amount,
time, place, and business
purpose of the expenses to the
employer by adequate records.
Treas. reg. § 1.62-2(e)(3)
requires that, for expenses not
governed by I.R.C. § 274(d), the
employee must submit information
sufficient to enable the
employer to identify the
specific nature of the expense
and to conclude that the expense
is attributable to the
employer's business activities.
Fair tool rental value,
regardless of the accuracy of
its estimation, does not satisfy
this requirement, as it does not
provide any information about
the amount of, or the specific
nature of, any expenses paid or
incurred by the employee.
The requirements set forth in
Treas. reg. § 1.62-2(f)
regarding the return of amounts
in excess of expenses further
clarify that only expenses
actually paid or incurred may be
treated as paid under an
accountable plan. Employees are
required to return to the payor
within a reasonable period of
time any amount paid in excess
of expenses substantiated. This
section specifies that an
arrangement advancing money to
an employee to defray expenses
will satisfy the requirements of
an accountable plan only if the
amount of money is reasonably
calculated not to exceed the
amount of anticipated
expenditures and the advance is
made on a day within a
reasonable period of the day
that the anticipated
expenditures are paid or
incurred. A regular, routine
allowance or advance for the
rental value or use of tools
would not meet this requirement.
Each tool reimbursement
arrangement should be reviewed
to determine whether the
accountable plan rules are met.
In addition to the factors
previously discussed, there are
other factors to take into
account. It is relevant to know
when the employer began
compensating its employees in
part with a tool reimbursement
program. It should be
ascertained whether the
arrangement is written, and, if
so, the writing should be
reviewed to determine if its
terms comply with the
requirements of an accountable
plan. Such writing may be in
the form of a lease, an employee
handbook, or an employment
contract. Whether the written
terms of the arrangement are
actually followed is important.
The service technicians'
understanding of the arrangement
also should be considered.
Employers frequently assert that
it is industry practice to pay
service techs for the use of
their tools. There is no
"industry practice" exception to
the accountable plan
requirements. After analyzing
the tool reimbursement
arrangement, a determination can
be made whether it meets the
accountable plan requirements.
Documents to Request - Service
Technician Tool Reimbursement
Employee Contract
Employment Handbook
Employee Lease Agreement
List or Schedule of Service
Technicians
Forms W-2
Audit Techniques - Service
Technician Tool Reimbursement
Determine by review of the
tool reimbursement
arrangement whether the
accountable plan rules are
met. There are three
requirements:
Business Connection
Substantiation
Returning amounts in
excess of expenses
Determine when the employer
began compensating its
employees in part with tool
reimbursement program.
Ascertain if the arrangement
is in writing, and if so,
the review for the three
requirements of an
accountable plan mentioned
above.
Examples of written form
are: in the form of a lease,
an employee handbook or an
employment contract.
Ask the employer if the
written terms are followed;
consider the service
technicians' understanding
of the arrangement.
There is no industry
practice exception to the
accountable plan
requirements.
Test compliance: Determine
if expenses were not
substantiated nor excess
expenses were returned to
the employer within a
reasonable amount of time.
These unsubstantiated or
excess amounts are paid to a
Non-accountable plan subject
to Employment Taxes. The
taxpayer
(employer/dealership) is
liable for the withholding
taxes unless the employer
can show the employees
related income and
employment tax liability has
been paid.
2.
MANUFACTURER'S INCENTIVE
PAYMENTS TO VEHICLE SALESPERSONS
Incentive payments received as
bonuses, prizes, or other
incentive awards paid directly
by the automotive manufacture or
through the dealer to
salespersons are not subject to
federal withholding tax (FIT) or
federal insurance contribution
act (Social Security Tax -
FICA). Moreover, these payments
are not considered to be
self-employment income and are
not subject to self-employment
tax. These payments are reported
as "other income" on their
federal income tax return, Form
1040. Revenue Ruling 70-337
explains that the salespersons
are under direct control of the
dealership, who performs the
hiring and training functions
and have all common law rules
apply at the dealership level.
The manufacturer directs
payments the dealership or
salesperson based on a sales
quota or other sales incentive
reached. The ruling also
explains these payments are not
considered wages for purposes of
FICA. Similarly, no expenses may
be taken on Schedule C to offset
incentive payment income. Any
ordinary and necessary business
expenses incurred by
salespersons must be reported on
Schedule A subject to the 2% AGI
limitation. Revenue Ruling
70-337 explains salespersons are
under direct control of the
dealership, which performs the
hiring and training functions
and all common law rules apply
at the dealership level.
Publication 3204 provides a
summary of how these payments
should be reported.
3.
SHUTTLING SERVICES AND
DRIVER/SHUTTLERS
A dealership often uses a
vehicle transportation business
provide services sometimes
referred to as "hiking" or a
"shuttling" service to transport
vehicles to and/or from the
dealership. For example, car
rental companies will use
transportation companies to
transport old rental cars to
auction sites. The
transportation service may be
hired by the dealership as an
independent contractor.
Summarizing the findings in
Leb's Enterprises, Inc. v US
2000-1 USTC 50,182 indicate that
payments to the drivers
performing the services were
determined to be employees
subject to employment taxes by
the employer.
The case involved a vehicle
transportation business (Leb's).
Leb's provided service for
various manufacturers of
vehicles and vehicle leasing
companies. The various companies
hired Leb's to move a vehicle
from one location to another.
Leb's also provided services for
other different companies and
Leb's drivers were usually paid
a flat rate based upon the
distance driven. Leb's treated
most of these drivers or
shuttlers as independent
contractors.
The Revenue Agent reviewed Leb's
schedules of payments to workers
(drivers), 1099s, employment tax
return, reimbursement schedules,
time cards, ledgers and
interview questionnaires, and
determined and had been
incorrectly classified as
independent contractors.
Moreover it was determined that
all of Leb's workers did
substantially similar work.
Leb's treated the workers of its
two main clients as employees,
but treated its workers from
other clients as independent
contractors. It also found that
many individuals who worked for
the two main clients were
treated as independent
contractors.
The court looked at the
taxpayer's consistent treatment
of its workers by examining the
workers' specific job duties.
The court looked at the job
performed not the relationship
between the workers and the
taxpayer. In Ren-Lyn Corp.,
968 F. Supp 363 (N.D. Ohio 1997)
the court determined that the
law does not require that the
workers performed identical job
duties, only that they perform
substantially similar job
duties. The court found that the
workers performed substantially
similar work; however workers
for one client were designated
and treated as employees, but
the other workers were being
treated as independent
contractors. As a result, Leb's
was not entitled to the safe
harbor relief provisions under
§530.
The court then reviewed the
facts about the classification
of the workers. The court found
that Leb's workers should have
been treated and designated as
employees and not independent
contractors under federal tax
laws. This is due to the
considerable control of the
workers including: means and
method, result of individual's
work, written instructions about
the process and procedures
involved in delivering the
vehicles to their destination
and certain time interval of
delivery. Each of the workers
were to call Leb's once or twice
a day while they were on the
road and complete employment
applications, take drug tests
and attend mandatory meetings.
The workers had very little
investment in their job.
The court also found support for
its holding from the Second
Circuit's decision in Avis
Rent-A-Car System, Inc. v.
United States, 503 F.2d 423
(2d Cir. 1974). In that
decision, the Second Circuit
held that the workers that
performed car shuttling services
were employees and were
improperly treated and
designated as independent
contractors under employment tax
law.
Documents to Request:
List or schedule of car
shuttlers, porters or car
drivers
Secure schedule of payments
to workers
Secure Form 1099's
Time cards and ledgers
Secure Employment
agreement/contracts
Secure copies of independent
contractors agreements
Audit Techniques
Review employment tax
returns
Inquire about the company's
policy on classification of
workers
Review Form 1099's and match
against list of employees.
Inquire about reimbursement
schedules.
Review source documents such
as time cards and ledgers.
Review company policy about
employment applications.
Review copies of independent
contractors agreements.
Have affected individuals
answer questionnaires that
consider the twenty common
law factors in Revenue
Ruling 87-41.
4.
HOLDBACK CHARGES
When dealers acquire their new
car inventory from
manufacturers, usually the
invoice includes a separately
coded charge for "holdbacks."
Dealer holdbacks generally
average 2-3 percent of the
Manufacturer's Suggested Retail
Price (MSRP) excluding
destination and delivery
charges. These amounts are
returned to the dealer at a
later date. The purpose of the
"holdbacks" is to assure the
dealer of a marginal profit.
During the examination, the
agent should verify that the
dealer is not booking
"holdbacks" as part of
purchases, cost of sales, in
valuing inventories, or as any
other deduction for Federal
income tax purposes.
Example
From "window sticker":
MSRP
$10,000
Destination Charges
400
MSRP Retail Total
$10,400
From Dealer Invoice:
Vehicle Factory
Wholesale Price
$9,000
Destination Charges
400
Advertising
Association
100 1% of MSRP
Holdback
300 3% of MSRP
Total Invoice Price
$9,800
Holdback: coded amount
is
(300) 3% of MSRP
Inventory Cost to the
Dealer
$9,500
Dealer makes the
following entry on its
books:
Inventory
9,500
Accounts Receivable
("Holdback")
300
Accounts Payable
9,800
Dealer makes the
following entry on its
books upon receipt of
"Holdback" payment from
the manufacturer:
Cash
300
Accounts Receivable
300
Documents to Request (note,
some of these may already be
available and previously
requested during initial
contact with the
dealership/taxpayer):
Dealer's Invoices of
Vehicle Purchases
Purchases Journal
General Ledger
Sales Journal
Audit Technique
Compare the dealer's
invoice with the
Purchases Journal and
the General Ledger to
determine whether dealer
is correctly reporting
the "Holdback" amounts.
If the dealer properly
books the "Holdback"
amount at the time the
vehicle is purchased,
there should not be any
reference made to the
"Holdback," in the sales
journal, at the time the
vehicle is sold to the
customer.
The Holdback identified as a
separately stated charge on
the dealer invoice as part
of the dealer cost is for
example purpose. The amount
may show somewhere on the
invoice but as information
for accounting purposes and
not as an element of dealer
cost.
Law
Rev. Rul. 72-326 provides
that the dealer cannot
include the $300 "Holdback"
as an inventory cost. Thus,
the car should be included
in inventory at $9,500 and
the $300 carried in a
receivable account from the
factory/manufacturer. The
manufacturer, on the other
hand, is not required to
include the "$300 Holdback"
in income.
Brooks-Massey Dodge Inc.
v. Commissioner 60 T.C.
884 (1973). The amounts of
an accrual basis dealer
discount held back by the
manufacturer under a plan
agreed to by the dealer was
taxable to the dealer in
years the amount was
credited to the dealership's
account rather than in years
received.
5.
WARRANTY ADVANCES
Dealerships perform work on
vehicles, as a result of
defective materials or
workmanship at the time of
manufacture. The manufacturer
subsequently reimburses the
dealership. Because of the time
delay from when the work is
completed and the date the
manufacturer pays the claim, the
manufacturer issues credit
memoranda or advances to the
dealerships based on an
averaging calculation (average
of warranty claims submitted in
a month) thereby reducing the
accounts payable of the dealer
for parts purchased from the
manufacturer. The purpose of the
arrangement is to allow the
dealer a credit against amounts
owed to the manufacturer before
the manufacturer processes the
warranty bill.
The amount of the credit is
adjusted at the beginning of
each year based on the average
of the previous 12 months
warranty claims filed and
approved. Since dealers use an
accrual method of accounting,
all amounts due it from the
manufacturer for warranty work
performed through the end of the
taxable year are includable in
gross income. Accordingly, the
amounts represented by the
credit memorandum issued by the
manufacturer, pursuant to the
credit arrangement, are not
includable in the gross income
of the dealer, but merely
represent a reduction of the
accounts receivable representing
the amount due from the
manufacturer for warranty work
performed.
Example-Warranty Advances
Adjusting Journal Entry:
Credit Memoranda: ABC
Manufacturer
$10,000
Parts Purchased . ABC
Manufacturer $10,000
To record warranty
advances from ABC
manufacturer
Documents to Request-
Warranty Advances
Credit Memorandums from
Manufacturer
Accounts Payable Journal
Accounts Receivable
Journal
General Ledger
Dealer Franchise
Agreement
Audit Techniques-Warranty
Advances
Review adjusting journal
entries or reversing
entries at year
end/beginning of year
for warranty advances
and compare to Other
Income.
Determine that accounts
receivable from
manufacturer reflect
reduction of income of
warranty advance.
Determine that accounts
payable of the dealer is
reduced for parts
purchased from the
manufacturer of warranty
advance.
Review dealer franchise
agreement to for the
provision of a credit
arrangement on warranty
advances or other
provisions set up for
warranty work.
Law
IRC section 446(a) provides,
in pertinent part, that
taxable income shall be
computed under the method of
accounting on the basis of
which the taxpayer regularly
computes his income in
keeping his books.
IRC section 451 provides
that the amount of any item
of gross income shall be
included in gross income for
the taxable year in which
received by the taxpayer,
unless, under the method of
accounting used in computing
taxable income, such amount
is to be accounted for as of
a different period.
Rev. Rul. 72-595
The amounts represented by
the credit memorandum issued
by the manufacturer are not
includable in the gross
income of the dealer, but
merely represent a reduction
of the dealer's accounts
receivable for amounts due
from the manufacturer for
warranty work performed.
6.
FINANCE RESERVES
One income issue found in new
car dealerships has to do with
the manner in which Finance
Income is reported. When
dealerships sell cars, they also
arrange financing for the buyer.
These finance contracts are
usually sold to a financial
institution and the dealership
typically participates in the
income derived from these
contracts. The amount of income
depends on a pre-arrangement
with the financial institution
where the dealership earns a
greater amount if the financing
is more lucrative.
Ordinarily, the financial
institution and the dealership
establish an account called a
"Dealer Reserve Account" that is
credited, with the dealership's
"commission" for arranging
financing for the buyer, when
the financing company determines
the income allocation. This
account may also be charged
(reduced) when a contract with
recourse to the dealership
defaults. In most instances the
financial institution holds part
of the dealer's reserve to cover
contingent events (i.e. in the
event the note is prepaid early
or the car is repossessed).
I. Example
A dealer sells a car to a
customer for the following:
Sales Price (including Sales
Tax and license fees) $10,000
Less: Down
payment
1,000
Balance to be
Financed
$ 9,000
Finance Charge @ 10
percent
900
Face amount of Installment
Note
$ 9,900
The dealer sells the note to
a finance company that agrees to
pay the dealer a 20 percent
commission on
the finance charge, or $180.
The correct way for the dealer
to handle the transaction is as
follows: Debit
Credit
Cash
9,000
Finance Charge
Receivable
180
Customers' account
receivable
9,000
Finance
Income
180
See current IRM.
Audit Techniques--Finance
Income
Determine the presence
of a "deferred income"
account.
Inspect the monthly
statements submitted to
the dealer by the
finance company (is).
Probe into the possible
existence of related
corporations set up to
handle the installment
notes. See also the
chapter on Related
Finance Companies in
this Guide.
Sample selected
transactions to verify
that the taxpayer was
using the accrual
method.
Law
In Commissioner v.
Hansen, 360 U.S.
446 (1959), the Supreme
Court held that the amount
held back or retained by the
finance company is taxable
to the dealership at the
time the installment note is
sold and the dealership has
a fixed right to the reserve
account.
Dealers must include in
income all amounts placed in
the reserve all deposits
into the account regardless
of use. See Resale Mobile
Homes, Inc. v. Commissioner,
965 F.2d 818 (10th Cir.
1992).
COMPENSATION ISSUES
In addition to the normal
employment tax requirements
applicable to auto dealerships,
there are other employment tax
considerations unique to the
auto industry.
1.
Auto Demonstrator Vehicles
In December 2001, IRS issued
Revenue Procedure 2001-56. This
revenue procedure provides
guidance for the taxation of the
personal use of an auto
demonstrator vehicle provided by
automotive dealers to their
employees. This revenue
procedure allows the dealer,
instead of the salesperson, to
determine the taxability of a
demonstrator vehicle. An auto
dealership may use any of the
methods in the revenue procedure
OR may use the existing rules as
defined in IRC 132(j)(3) and
Reg. 1.132-5(o)(4).
Rev. Proc. 2001-56, and
Publication 4230 for taxpayers,
provides four methods to
determine the amount taxable to
the employees:
Full Exclusion Method
- clarifies the existing
rules under current law.
This method provides
complete exclusion from
taxation for the use of a
demonstrator vehicle.
Simplified Out/In Method
- provides simplified record
keeping requirements for the
Full Exclusion Method.
Partial Exclusion Method
- allows for partial
taxation of an auto
demonstrator vehicle with
limited record keeping
requirements. Most auto
dealerships are expected to
adopt this method.
Full Inclusion Method
- allows a dealership to use
the Annual Lease Value
tables, as defined in Treas.
Reg. 1.61-21(d)(2)(iii), to
determine the taxable value
of a demonstrator.
If the auto dealer cannot
qualify for one method, the
dealer may qualify for one of
the other three methods.
In order to use any of the
first three methods, the
driver of the demonstrator
vehicle must qualify as a
full-time salesperson and the
dealership must have a written
policy. A sample written policy
is included in Appendix A and B
of the revenue procedure.
The rules to qualify as a
full-time salesperson are: [ref.
IRC 132-5(o)(5)]
Must be a full-time employee
of an automobile dealer
Must spend at least half of
a normal business day
performing the functions of
a floor salesperson or sales
manager
Must directly engage in
substantial promotion and
negotiation of sales to
customers
Must derive 25% of his or
her gross income directly as
a result of sales activities
The written demonstrator
agreement must contain the
following:
Prohibit the use of the
vehicle outside of normal
business hours by
individuals other than
full-time salespeople
Prohibit the use of the
vehicle for personal
vacation trips
Prohibit use outside of the
sales area in which the
dealership's sales office is
located
Prohibit storage of personal
possessions in the vehicle
Employer must reasonable
believe that the salesperson
complies with the written
policy
Any full time employee of the
dealership can use the fourth
method.
Full Exclusion Method1
The Full Exclusion Method allows
for full exclusion from taxable
income, the use of a
demonstration automobile by a
full-time automobile
salesperson. This method
clarifies the existing tax
treatment of auto demonstrators
under IRC 132(j)(3) and Reg.
1.132-5(o)(4).
It is expected that most
dealerships will NOT adopt this
method.
Simplified Out/In Method2
The Simplified Out/In Method
provides a simplified method for
a dealer to document the use of
a demonstration automobile by a
full-time automobile
salesperson. Under this method,
the total miles that a
demonstrator is used during
normal working hours is
considered business miles and
only mileage outside of normal
working hours is considered.
For each demonstrator, the
dealer must record the mileage
at the end of the day and again
at the beginning of the
following day. The miles driven
during this time cannot exceed
the salesperson's commute plus
10 miles. The employer must
determine if the personal miles
exceed an average of 10 miles
per day, no less often than
monthly. If the average personal
miles are less than 10 miles per
day, and all other requirements
of this section are met, the
salesperson's use of the
demonstrator is not taxable.
The taxpayer is required to
maintain the following records:
Evidence that the
salesperson's personal use
by mileage was calculated no
less often than once each
calendar month. This may
include:
Records identifying each
demonstrator assigned to
each salesperson
Records identifying the
total mileage for each
demonstrator
Records supporting the
total use outside of
normal working hours.
Employer should maintain
records of out and in
mileage of the
demonstrator for each
day it is used.
Records identifying the
round trip commuting
mileage of each
salesperson assigned a
demonstrator from the
salesperson's home to
the dealer's sales
office.
The employee is not required to
maintain any records except to
the extent the employee is
required to provide information
to the dealer to allow the
dealer to maintain the records
as noted above.
Partial Exclusion Method3
The "Partial Exclusion Method"
provides that an amount is to be
included in the taxable income
of a full-time salesperson at
least monthly for the use of the
demonstrator vehicle. Under this
method, the dealer is not
required to keep any records
documenting the use of the
demonstrator.
The taxable amount is obtained
from the table below and is
based upon the value of the
vehicle. The taxable amount
applies for each day a
salesperson is provided a
demonstrator, including non-work
days.
Value of the Demonstration
Automobile Daily
Inclusion Amount
0 -
$14,999
$3
$15,000 -
$29,999
$6
$30,000 -
$44,999
$9
$45,000 -
$59,999
$13
$60,000 -
$74,999
$17
$75,000 and
above
$21
Full Inclusion Method4
The Full Inclusion Method is
available to any full-time
employee of the dealership. This
method allows an automobile
dealer to use the Annual Lease
Value tables [Ref
1.61-21(d)(2)(iii)] to determine
the amount the employee must
include in his or her income for
their use of a demonstrator
vehicle. This method does not
allow any reductions in
the inclusion amount for the
employee's business use.
The dealer is required to
include the taxable amount in
the employee's wages no less
often than monthly.
Annual Average Look Back
Method5
The "Annual Average Look Back
Method" is available for a
dealer to determine the value of
his or her demonstration
vehicles provided to its
salespersons when the dealer is
using the Partial Exclusion
Method or the Full Inclusion
Method. This method may be used
to value the dealerships'
demonstrators instead of valuing
each demonstrator individually.
The value of any new
demonstration automobile is
based on the average sales price
of all vehicles sold in the
prior year. It is calculated by
taking the sum of the sales
prices of all new car and truck
sales in the prior calendar year
and dividing that sum by the
number of new vehicles sold in
the prior year.
Example:
In 2001, (Manufacturer's
Statement) New Car Gross
Receipts: $23,226,000
The dealership sold 948
vehicles
$23,226,000 =
$24,500 annual average
vehicle
948 vehicles
Using the table provided for
the Partial Exclusion
Method, the amount
calculated above is between
$15,000 to $29,000 range and
the daily inclusion amount
accordingly is at $6.00/day.
Using the table provided for
the Full Inclusion Method.
The amount calculated above
is between $24,000 - $24,999
range and the daily
inclusion amount accordingly
is at $18/day.
The average sales price must be
determined in January of each
year and must be applied no
later than February of that
year. In the above example, for
each month ending on or after
February 1, 2002 to January 31,
2003, the dealer includes in the
employees W-2, $6 per day under
the Partial Exclusion Method and
$18 per day under the Full
Inclusion Method.
Some manufacturers' statements
state the value of demonstrator
vehicles as a separate line
item. The dealership is
permitted to use this value
instead of the broader New Car
Gross Receipts item. However,
the dealership must the same
method from year to year.
Consistency is required
Revenue Procedure, 2001-56,
Question 34 provides several
examples of determining the
annual average sales price of a
demonstrator vehicle. For
example, if the dealership
operates more than one franchise
at a single physical location,
the annual average sales price
for all salespeople may be based
on the combined sales of all
franchises operating at that
store.
If a salesperson is only
provided demonstration
automobiles from a single
franchise operating out of the
store, the dealer may base the
annual calculation of value of
that salesperson on the sales of
the specific franchise. In that
case, the value for all
salespeople in the store must
also be based on specific
franchises.
The dealer can use this method
for used car demonstrators.
Questions 33 and 34 address
scenarios for used car
demonstrators.
Documents to Request
The dealership's written
demonstrator policy
Payroll records including
W-2's and payroll journals
Listing of employees that
were given a demonstrator
vehicle
Determination of the
valuation of the
demonstrator vehicles
Audit Techniques
The dealership is not required
to make an election to use any
of the methods in Revenue
Procedure 2001-56. Upon
examination, ask the dealership
which method, if any, the
dealership adopted.
As stated earlier, it is
expected that most dealerships
will adopt the Partial Exclusion
Method. The agent should verify
the following:
The dealer has a qualified
written policy, the policy
was communicated to
employees, and there is no
evidence that the
salesperson violated the
written policy.
Documentation of
communication to
employees of the policy
may include a copy of a
poster notifying
employees, a copy of a
letter or electronic
communication, or signed
statements by the
employees acknowledging
receipt of the written
policy.
Payroll records should
indicate that withholding
and income are properly
accounted for on a monthly
basis
The dealer is not
permitted to elect under
IRC 3402(s) not to
withhold income taxes
from the portion of the
vehicle fringe benefit
required to be included
in the employees' W-2.
The monthly
withholding
requirement is
intended to
substitute for more
specific record
keeping requirements
for substantiating
the use of the
demonstrator. Annual
inclusion and
withholding of other
employment taxes
with respect to
noncash fringe
benefits allowed
under Announcement
85-113, 1985-31
I.R.B. 31 is
unavailable under
the methods provided
by this revenue
procedure. 6
Salespersons are assumed to
have the use of a
demonstrator for every day
of the period under
consideration. If the dealer
states otherwise, he or she
should be able to provide
evidence.
The dealer should be able to
support the determination of
the value of the
demonstrators. If the dealer
has multiple franchises,
locations and/or has used
vehicles for demonstrators,
the dealer must be
consistent in the valuation
method
that is employed.
If a dealership does not qualify
for one method, the dealer may
still qualify to use one of the
other methods described in the
revenue procedure.7
Examples:
If a dealership attempts to
use the Simplified Out/In
method and does not qualify
(i.e. average personal miles
> 10 miles per day), the
dealer can use the Partial
Exclusion method as long as
the correct tax is withheld
from the salesperson.8
If a dealership attempts to
use the Partial Exclusion
method and does not qualify
(i.e. employee not a
full-time salesperson), the
dealer can use the Full
Inclusion method as long as
the correct tax is withheld
from the salesperson.9
Inadvertent Errors
Revenue Procedure 2001-56,
Question 51 addresses
inadvertent payroll errors. If
an error is identified and
corrected during the calendar
year, the dealership is
permitted to use the revenue
procedure. If the error is NOT
corrected within the calendar
year, the dealership must
determine the taxable amount
under the general valuation and
substantiation rules.
Employees other than full-time
salespeople
If the employee provided the use
of a demonstrator is not a
full-time salesperson, the full
exclusion and the partial
exclusion methods do not apply.
The employer may use the full
inclusion method to determine
the value of the demonstrator,
but cannot reduce the taxable
amount to account for business
use by the employee.
Treas. Reg. 1.274-6T provides
other methods for excluding from
an employee's income a portion
of the value of the use of a
demonstrator. This regulation
generally allows an employer
implementing certain written
policies restricting personal
use to account for commuting and
de minimis personal use by any
employee by including the $1.50
per one-way commute provided
under Treas. Reg. 1.61-21(f)(3)
in the employee's income and
providing other evidence
allowing a determination that
use was actually limited.
