In Revenue Procedure 2001-56, the IRS provides guidance for the taxation of personal use of a demo vehicle. Basically, in addition to computing a W-2 inclusion amount, a dealer will need to have and retain a written demonstrator policy that includes the following information:
- documentation of communication to employees
- payroll records, including Forms W-2 and payroll journals
- list of employees with demos
- valuation of the demos
Upon an IRS audit, the agent will review the demo policy and calculations for all open tax years and will assess additional payroll taxes and penalties for all years if a deficiency is found. This can be a big deal, costing you a bundle if discrepancies are large and go back several years.
By following a few simple procedures and calculations under the ruling, you can save yourself a lot of headache and money should the IRS ever come knocking.
Here is a basic example of typical demo calculations under the revenue procedure:
Dealership A has 10 full-time employees with demos. The owner, general manager, controller, new car sales manager, used car sales manager, three new salespeople and two used sales people have demos.
Step 1: Determine who qualifies as a full-time salesperson versus a non-salesperson under the procedure. Qualifying as a salesperson minimizes the income inclusion amount. A qualifying salesperson is:
- an employee of the dealership who spends at least 50% of a day performing the duties of a floor salesperson or manager, and derives at least 25% of compensation from direct sales activities
- directly engaged in negotiations of sales to customers
- full-time and works not less than 1,000 hours per year
In our example, the five salespersons qualify, the sales managers qualify, and the general manager will qualify as long as he/she meets all of the above criteria. The owner and controller will not qualify.
Step 2: Determine the inclusion method to use. Although there are several choices under the revenue procedure, most dealers will choose the Simplified Partial Exclusion option for qualifying salespersons, and Simplified Full-Inclusion Method for all other employees. These two methods are most commonly used because mileage records are not required.
In our example, the qualifying salespersons – general manager, sales managers and salespersons – will use the Simplified Partial Exclusion method. The owner and controller will use the Simplified Full-Inclusion Method.
Step 3: Determine taxable value. First determine the value of the demo by using the Annual Look Back Method, which looks at the average sales price for vehicles sold in the previous year. The average sales price is determined by dividing the total vehicles sales for the year by the number of vehicles sold. New and used average sales price is determined separately. For example, if total new sales are $16,497,222 for 705 vehicles, the average value is $23,400 for a new demo. If total used sales are $9,850,555 for 1220 used vehicles, the average value is $8,074 for a used demo.
Once the average sales price "value" is calculated, the taxable inclusion amount is determined by using the appropriate table in Rev. Proc. 2001-56. The Simplified Partial Exclusion table would be used for qualifying salespersons, and the Simplified Full Inclusion table would be used for non-salespersons – in our case the owner and controller.
For example, the taxable inclusion amount for a new demo with a value of $23,400 for a salesperson is $6 per day and for a non-salesperson, $17 per day. The taxable inclusion amount for a used demo with a value of $8,074 for a salesperson is $3 per day and for non-salesperson, $7 per day. The daily rate is applied to the total number of days the demo is available for use, and the amount must be included in the employee's wages at least monthly.
In our example, let's assume the general manger, new car sales manager and three new car salespeople, all qualifying salespersons, have new demos. Their daily inclusion rate would be $6 per day. Also assume the owner, a non-salesperson, has a new demo. His/her daily rate would be higher at $17. Assume next that the used vehicle sales manager and two used vehicles salespeople have used demos. If so, their daily rates are $3 per day. Let's assume last that the controller, a non-salesperson, also has a used demo. His/her daily rate would be $7 per day. Using just the owner as an example, assuming the demo was available for use for the full year, the annual inclusion amount included on the W-2 would be $6,205.
Note that there are other special rules related to vehicle changes, partial months, etc. that can be found in the revenue procedure.
What is important to note is that estimated inclusion amounts are not allowed, and they can get you in trouble should the IRS find that the inclusion amount falls short.
If you would like a sample Demonstrator Policy packet, which includes a copy of the W-2 inclusion tables found in Revenue Procedure 2001-56, please contact our office.
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