Insights

The IRS is determined to classify auto dealers, at least to some extent, as wholesale distribution centers and producers as opposed to simply retail stores. As such, dealers would be forced to use a complicated formula to capitalize costs as inventory that will increase their taxable income. The common name for this requirement is UNICAP, and it could cause a typical dealer to pay taxes on hundreds of thousands of dollars of phantom income in 2010. This tax consequence would come at a time when dealers are already reeling from decreased demand for their product, two major manufacturer bankruptcies and tight credit markets.

Retail facilities are exempt from UNICAP so most dealerships are not bound by these rules. The IRS, however, has been trying for years to require dealers to submit to UNICAP. They propose to treat leases and dealer trades as wholesale sales, which would require most dealers to be classified as “dual function” facilities – part retail outlet and part wholesale distribution center.

The IRS bases its conclusion on advice from its national office in September 2007 as it related to one particular examination. This type of advice is applicable only to the specific taxpayer’s case and does not set legal precedent. However, the IRS, in a directive to its agents in September 2009, stated that it is their position to apply the legal arguments from the 2007 technical advice to all auto dealers. It has suspended audit activity as it relates to UNICAP until 2011 to allow dealers across the country time to “comply with (the IRS’) legal reasoning”. 

Paul Metrey, Director of Regulatory Affairs for the National Auto Dealers Association, has been working to get the IRS to reconsider its position or at least extend the time for suspension of audit activity until a proper review is undertaken. In a letter to the IRS and the Treasury Department dated December 1, 2009, Mr. Metrey complains that the IRS’ position is “based on incomplete, non-precedential technical advice (which was) issued without public comment”. He also requests that the IRS extend its ongoing review of UNICAP matters to the particular issues confronting franchised car and truck dealers and to extend the suspension of UNICAP activities until a proper rulemaking process can be completed.

In the meantime, dealers remain confused because there is no clear legal guidance from the IRS. Hopefully, we will have some before the end of the suspended audit period on December 31, 2010.

Schneider Downs provides accounting, tax, wealth management and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh, PA, and Columbus, OH.

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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