THE MORE THINGS CHANGE...
By Bradley Nicklin
Another year has come and gone. I have a feeling that 2008 is going to be another year of "the more things change, the more they stay the same." The DMS market will continue to be one of uncertainty, with major new entrants poised to enter and "change the game" without the game actually changing. The domestic manufacturers will continue to both struggle and show promise at the same time, as they deal with right-sizing their franchise levels and creating product that resonates with consumers. And dealers that stick to the basics and focus on providing great customer service will continue to thrive.
In this issue, we highlight two tax issues that illustrate the more things change, the more they stay the same. I will review the latest information from the IRS regarding Tool Reimbursement plans, and how the IRS continues to maintain its position that these plans are not acceptable. Scott Barnard outlines the IRS' latest attempt at positioning the UNICAP rules to increase tax revenue, an effort some of their agents have been pursuing recently.
On the other hand, one thing that has changed is the passing of the trade differential in Maryland. In my opinion this is a great thing for Maryland dealers at an operational level. For those of you that haven't worked in a location that has the trade differential, it basically means that your customer is only taxed on the net amount of the vehicle they are purchasing - the value of the trade is subtracted from the taxable amount. This creates an additional incentive for customers to buy from a dealer and to trade their vehicle. While I know that a deal is much easier and cleaner without a trade, in the current market with the increasing importance of used vehicle sales, it provides access to more inventory that might otherwise have been sold privately or ended up on eBay. It weights the overall financial benefits of buying a car from a dealer rather than privately in your favor. Take the time to discuss this new situation with your used car manager and determine how to incorporate it into your sales and marketing strategy.
IRS LOOSENS "ABOVE-THE-LINE" INSURANCE DEDUCTIONS FOR S CORPORATION SHAREHOLDERS
The IRS has clarified the rules regarding the deduction by two-percent shareholder-employees of S corporations for health insurance premiums paid or reimbursed by an S corporation and included in the shareholders' income. A two-percent shareholder-employee may deduct amounts paid for insurance under Code Sec. 162(l) if the insurance plan was established by the S corporation. A plan is considered to be established by the S corporation if the S corporation makes the premium payments in the current tax year or the two-percent shareholder makes the premium payments and is, then, reimbursed by the S corporation in the current tax year. Payments, whether made directly by the S corporation or reimbursed by the S corporation, must be included in the shareholder's wages and reported on the shareholder's Form W-2, Wage and Tax Statement. This is excellent news for the numerous shareholders who currently purchase their own health insurance.
TOOL PLANS REMAIN ON THE IRS HIT LIST
By Bradley Nicklin
For years, Beers + Cutler has advised its clients to steer clear of the tool reimbursement plans that have been highly promoted. The latest IRS Letter Ruling is not boding well for those dealers that signed on with these types of programs. Private Letter Ruling 200745018 was released on November 14, 2007, and it appears to put the taxpayer back in the position they were prior to signing on with the tool plan program with the potential for abuse to be part of the conclusion. The Letter Ruling is not too dissimilar from the Revenue Ruling 2005-52 conclusions where the IRS addressed the tax consequences of a tool plan.
Background
Tool plans have been marketed as a tax savings strategy to reduce the amount of payroll tax and withholding while at the same time not changing the amount of compensation paid to a service technician.
Reimbursements are tax free to employees and are not subject to withholding or payroll taxes if made under an accountable plan. To qualify under the accountable plan rules the plan must meet all the following criteria:
Facts of the Letter Ruling
The taxpayer's employees, service technicians, were required to provide their own tools as a condition of employment. The tools ranged from simple wrenches to sophisticated power tools and computer analysis equipment. The tool plan promoter approached the taxpayer about implementing a program as a tax savings opportunity for the reimbursement of the technicians' tool expenses without requiring the taxpayer to pay to the technicians any additional cash over their current hourly wages. The tool plan enrollment form required the technicians to list the tools they were required to provide for purposes of their job and to provide the cost of each category of tool. In addition, technicians signed a statement that they only used the listed tools and equipment for their employer's business related activities and, at least in some cases, indicated they hadn't recovered any tool costs through depreciation or previous reimbursement. The taxpayer did not show that it had attempted to verify these statements. In addition, the taxpayer did not provide any evidence that it ever requested or obtained receipts to substantiate acquisition costs. Using the plan a technician's tool benefit was paid to him as an hourly reimbursement rate over a determined number of reimbursement hours. It was determined under the formula: (tool inventory + 10% fee) ÷ tool rate = reimbursement hours. The tool rate was based on 35% of the technician's current hourly wage, but it couldn't exceed $8.00 per hour and couldn't be an amount that caused the technician's remaining hourly wages to be below the legal minimum wage. To pay the tool benefit, the taxpayer divided the technician's compensation into two components: the hourly wage and the hourly tool rate. The sum of the two components equaled the technician's previous hourly wage.
IRS Conclusion
The IRS concluded that the tool plan as designed failed each of the three requirements for an accountable plan. The IRS took the stance that the tool plan merely recharacterizes a portion of the technician's compensation and labeled it as a reimbursement. The technician received the same hourly rate regardless of whether they incurred expenses. According to the Ruling, the accountable plan violations were not isolated errors with regard to a particular technician, time period or tool. The errors were routine and fundamental to the design of the plan, where the goal was to ensure that the gross pay of each technician never changed. This was believed to be a pattern of abuse by the taxpayer. According to the Ruling:
"The accountable plan rules were not meant to allow taxpayers to avoid paying taxes on their wages, even if for a short period of time, in the guise of expense reimbursement. The routine reimbursement of unsubstantiated expenses and the practice of recharacterizing wages as reimbursement until expenses are reimbursed, only to reinstate the original compensation amount at that point, evidence an abuse of the accountable plan rules."
Because of these failures and a possible pattern of abuse, the taxpayer's reimbursements to its employee technicians had to be included in their gross income and reported as wages or other compensation on their Form W-2, and were subject to withholding and payment of federal employment taxes.
If you have a tool plan in place we recommend a thorough review of your plan. We suggest reviewing the Letter Ruling to compare the design of that plan to yours. If you have a plan that might be in question, you should communicate with your service provider to see how your plan addresses the concern the IRS brings to light in the Letter Ruling.
THE IRS MAY HAVE A NEW VIEW OF UNICAP
By Scott Barnard
Dealers are subject to the Internal Revenue Code Sec 263A uniform capitalization (UNICAP) rules. These rules call for additional indirect costs to be capitalized into inventory that would not normally be capitalized under the traditional Sec. 471 full absorption cost accounting provisions. As a result, dealers may be required to treat certain costs as inventory costs that would otherwise be deducted as incurred. The typical inventory related costs that might be capitalized are purchasing, handling and storage. Over the last several years, we have advised many of our clients to adopt specific, simplified UNICAP methods. The use of these methods and meeting certain safe harbors can result in a zero UNICAP adjustment - no additional costs need to be capitalized.
Recently, the IRS has pursued new UNICAP theories, contending that dealers should be capitalizing even more costs under the premise that dealerships are not retail businesses and are instead producers. The UNICAP rules for producers can capture more expenses than for retailers. These challenges have occurred during IRS audits in certain areas of the country by particular IRS personnel. We are not aware of any audits where the IRS was ultimately successful with this "producer" theory after the examination appeals process.
An IRS agent did submit a case to the National Office for a technical advice memorandum (TAM) last year, claiming that the dealership's repair service on customer and dealership vehicles was a production activity, service department costs should be treated as handling costs and that the dealership was not an on-site retail facility because most of its sales were not retail sales (e.g., dealer trades, vehicle leasing, wholesale parts sales and sales of vehicles to wholesalers and at auctions). The IRS National Office issued the TAM in June and concluded that the repair of customer-owned vehicles was not production, but the dealership is a producer for repair work on vehicles held for sale by the dealership. Additionally, the IRS held that the dealership was not an on-site retail facility because most of the sales were not retail sales. The National Office did not give the agent everything they wanted, but apparently believes the producer issue has some merit.
A TAM is only applicable to the taxpayer under audit but gives some indication of the IRS thinking on certain matters. The TAM approach would likely add $100,000 or more to the annual UNICAP calculation for a typical single point dealer.
The producer issue has been added to the IRS guidance plan and may result in the issuance of a revenue ruling in 2008. We are advising that our clients take no action and continue their historical UNICAP methods (assuming they are following the existing UNICAP rules) until the IRS issues new guidance, if ever. As of this writing, there have been no updates from the IRS since the issuance of the TAM.
VIRGINIA'S CHANGING TAX LANDSCAPE
By Bradley Nicklin
We recommend all Virginia Dealers become very familiar with the new tax requirements affecting vehicles that will be garaged in the two special Transportation Authorities - Northern Virginia (now in effect) and Hampton Roads (effective 4/1/08).
Even if your facilities are not located in these areas, in this era of internet sales, your customers are coming from a wider geographic area and may be covered by these taxes - a 1% increase in sales tax and an additional $10 licensing fee. It's worth the time to implement standardized internal processes to make sure the appropriate taxes and fees are collected at the time of the sale - we all know how unhappy customers are when they are approached about paying additional taxes and fees after the sale.
Additionally, dealers located within these designated zones will need to begin collecting a 5% sales tax on service labor, an additional vehicle rental tax, and an additional fee on vehicle safety inspections. For greater detail on the new legislation, zone boundaries and compliance assistance, the VADA has put together an excellent document that can be found at http://dealers.vada.com/Legislative.aspx.