New Vehicle Dealership

Internal Revenue Service New Vehicle Dealership Audit Technique Guide (ATG) NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date. This material was designed specifically for training purposes only. Under no circumstances should the contents be used or cited as sustaining a technical position. The taxpayer names and addresses shown in this publication are hypothetical. They were chosen at random from a list of names of American colleges and universities as shown in Webster’s Dictionary or from a list of names of counties in the United States as listed in the U.S. Government Printing Office Style Manual. www.irs.gov Training 3147-120 (01-2005) Catalog Number 85870Y New Automobile Dealership Table of Contents Chapter 1 General Focus, Procedures and getting setting starting Introduction ........................................ 1 - 1 Getting Started . 1 - 1 Chapter 2 Books and Records Characteristics .............................. 2 - 1 Books and Records General Ledger Audit Example . 2 - 3 Conclusion ................................. 2 - 6 Chapter 3 Balance Sheet Introduction ........................................ 3 - 1 Conclusion . ....................... 3 -22 Chapter 4 Inventory Introduction ........................................ 4 - 1 A short history of LIFO application. 4 - 4 Chapter 5 LIFO Introduction ........................................ 5 - 1 LIFO Concepts ........................................ 5 - 1 Pooling….. ........................................ 5 -11 LIFO Election ........................................ 5 -16 LIFO Computations ........................ 5 -21 Chapter 6 Alternative LIFO for Auto Dealers Introduction ........................................ 6 - 1 LIFO Pooling….............................. 6 - 1 Used Vehicle Alternative LIFO Method…………………………… 6 - 9 Chapter 7 Extended Service Contracts and Aftermarket Products Introduction ........................................ 7 - 1 Extended Service Contracts ........................... 7 - 1 Credit Life Insurance; Credit Accident and Health Insurance . 7 - 2 General ESC . ....................................... 7 - 3 Agent versus Principal/Obligor . 7 - 4 Service Warranty Income Method (SWIM) . 7 - 9 VSC Audit Technique Flow Chart ........................ 7 - 19 Chapter 8 PORC Introduction ........................................ 8 - 1 General Structure Example ..................... 8 - 5 Applicable Code Sections . 8 - 6 Chapter 9 Advertising Associations Introduction ......................................... 9 - 1 Supporting Law .............................. 9 - 4 Chapter 10 Sales of Dealerships Introduction......................................... 10 - 1 Supporting Law ...................................... 10 - 5 Chapter 11 Related Finance Companies Introduction......................................... 11 - 1 Howdoes itwork?.................................... 11 - 1 Issue Identification . .................. 11 - 3 Initial Document requests................ 11 - 11 Supporting Law ........................ 11 - 13 Chapter 12 Passive / Non-Passive Considerations Introduction......................................... 12 - 1 Should this issue be considered? . 12 - 1 Conclusion ......................................... 12 - 2 Chapter 13 Voluntary Employees' Benefit Associations What is a VEBA …………………………………………… . 13 - 1 Issue Identification . .................. 13 - 3 Chapter 14 Other Auto Dealership Issues Introduction ...................................... .. 14 - 1 Service Technician Tool Reimbursements . 14 - 1 Manufacturer’s Incentive Payments to Vehicle Salespersons. 14 - 6 Shuttling Services & Drivers/shuttlers........ 14 - 7 Holdback charges. .................................. 14 – 8 Warranty advances…………………………. 14 - 10 Finance Reserves……………………........ 14 - 11 Compensation Issues. .................................. 14 – 12 Other Issues………….................................... 14 – 23 Glossary…………................................... …… 14 – 30 Sources of Information ................................... 14 – 31 Chapter 1 General Focus, Procedure and Getting Started INTRODUCTION In preplanning an examination of an automobile dealership, a review of the return, as is customary, could pose interesting questions to begin the audit. An agent knows there are a variety of internal research tools with which to start. By securing information from the Integrated Data Retrieval System (IDRS), an agent may be able to perform a preliminary comparative analysis of the income and deduction items as well as the balance sheet which would provide initial information useful to the agent. Many dealerships have begun conducting business transactions utilizing e-commerce, or the Internet. Using a search engine to look at a dealership’s website may provide some background information on a specific dealership. The return may be a consolidation of two or more entities created for the benefit of the automobile dealer. The separate entities provide the dealership the ability to clarify operations and distinguish activities. If the return is a large consolidated operation, flow- through schedules or other accompanying statements are disclosed on the return identifying these activities. New automobile dealerships maintain good internal controls and prepare complete books and records. Dealerships as franchisees, properly book sales activities to conform to the financial statement requirements imposed in the form of the manufacturers statements by the franchiser, the factory. Once the income is booked, some dealerships may incorrectly treat or classify them for tax purposes. This may occur through shifting of business activities to related entities. An entity chart is helpful in visualizing the organizational structure. It is important that all related returns are gathered. One entity may own the land where the dealership operations are and rent is paid to the shareholder. Another entity may be an insurance company formed to facilitate the paper flow of extended service contract sales or a management company is formed to receive management fees. All three are related entities and related party transactions should be examined. An understanding of each entity’s activities, business purpose and tax implications would be required. GETTING STARTED The key to a quick and competent closure of any new vehicle dealership examination hinges on narrowing the scope of the examination to items that may prove productive. This section addresses tools necessary to frame the scope of the examination and to transition from planning to the start of the examination of the books and records. Chapter 1, General Focus, Procedure and Getting Started 1 In order to determine the examination’s focus, request copies of the following before the initial interview. These documents form the cornerstone of any auto dealership examination: Pre-Interview Documents to request: 1. Unadjusted Trial Balance and Adjusting Journal Entries 2. Tax Classification Work Papers 3. Manufacturer's Statement Audit Techniques: 1. An agent obtaining this information before the initial appointment will be able to accomplish two objectives. a. First, the agent will be able to reconcile the trial balance to the tax return. b. Second, the agent will be able to ask more pointed questions during the initial interview. Reconciliation Regarding the reconciliation, it is recommended the agent do a full reconciliation of the trial balance and the adjusting journal entries to the tax return. By doing a little work up front the agent should have a specific understanding of the underlying transactions that make up the return. This is elaborated further in the next section. Often in a dealership examination, the liability accounts have special significance. If the dealership is thinly capitalized, there may be an issue.. The recommended reconciliation will enable the agent to analyze liability accounts to determine if any issues exist regarding loans or inter-company transfers. When the initial interview is held, the agents' questioning may be more specific regarding liabilities or any transaction analysis made possible through the reconciliation. Tax Classification Work papers (Tax Accountant’s/Preparer’s Grouping Sheets) The agent has requested the tax classification work papers. It is difficult to envision a return at the level of a new vehicle dealership to be prepared without the assistance of such work papers. When received, most of the reconciliation is completed and the agent has saved the up front time previously scheduled. Manufacturer’s Statement: In order to open and maintain a franchise, the auto dealership is required to furnish financial statements with the manufacturer on a regular basis, usually monthly. These manufacturer's statements are usually reliable, as shareholders in automobile dealerships do not want to risk losing their franchise rights and the manufacturer audits the dealerships frequently. For this reason, manufacturer's statements can be utilized to establish confidence in the taxpayer's books early and quickly in the examination process. The tax return filed by the dealership should be similar to the manufacturer's statements. For example, gross receipts should tie in to the tax return and any differences scrutinized. Any differences between the manufacturer's statements and the tax return that are large or unusual should

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