Dealers Face Significant Tax Cost if IRS Interpretation of UNICAP Sticks
Several misunderstandings and inconsistencies loom over how the uniform capitalization rules under IRC Section 263A (
UNICAP) should be applied to auto dealers. Recently, the IRS released a field directive reinforcing its position, yet is instructing examining agents to “stand down” regarding the 263A issue through December 31, 2010.
“This is the biggest tax issue facing dealerships today, and there is a lot of confusion about it,” says Jason Duffner, a dealerships principal with LarsonAllen. “And based on the current interpretation, virtually no dealers are in compliance.”
The potential tax exposure is tremendous if the IRS doesn’t change its position, he says. Single-store locations with moderate volume could see adjustments in excess of $100,000.
IRS investigation team introduces field directive
In the spring of 2009, the IRS formed a team to collect data and investigate the various issues surrounding auto dealer
UNICAP, which it believes represents the highest non-compliance risk in the dealership industry.
After the analysis, the team met with the IRS’s internal UNICAP team, the National Automobile Dealers Association (NADA), and others to recommend how to proceed. As a result, on September 15, 2009, the IRS issued Tier III - Field Directive on the Planning and Examination of IRC Section 263A Issues in the Auto Dealership Industry.
The memo, similar to 2007’s Taxpayer Advice Memorandum (TAM) 200736026, is not an official law or position, but it reinforces the agency’s position on UNICAP for automobile dealers. However, it does not constitute statutory authority, which must be followed in accordance with Circular 230.
Stand down period offers relief
"In a bit of good news, the field directive instructs field examiners to stand down on raising the 263A issue on new audits between September 15, 2009, and December 31, 2010, to allow time for auto dealers to comply with the IRS positions outlined in the TAM,”
Duffner says.
The stand down covers new and used car dealers as well as light, medium, and heavy duty truck dealers, but does not apply to RV or equipment dealers. The IRS will resume auditing IRC Section 263A in 2011.
Background on UNICAP
In the late 1980s, the tax code was modified to require retailers to capitalize the cost of carrying inventory. The change caused retailers (including dealers) to perform a calculation that included a portion of its handling, storage, and other overhead costs in its inventory. Previously, these costs were expensed as incurred. To calculate capitalized costs, the majority of dealerships began using a variation of the simplified retail method allowed by the
UNICAP rules. The result was a very minor adjustment to taxable income based on inventory fluctuations.
In 2007, the IRS issued TAM 200736026 limiting the use of the simplified retail method. It also called for capitalization of additional expenses in some cases. According to the IRS, compliance risks exist due to uncertainty about applying the TAM and inconsistent treatment by examiners. Read more background.
Terri Harris, the IRS’s motor vehicle technical advisor, said in a recent NADA
Webinar on
UNICAP that the IRS believes no dealers are complying with the
UNICAP rules. The current interpretation will force dealers to capitalize costs, causing a greater tax burden.
In the field directive, the IRS provides guidance for field examiners on how to conduct UNICAP audits of franchised car and truck dealers, including an “audit tool kit” developed by the IRS team. During the stand down period, the IRS will be working on refining and correcting some concerns already identified in the tool kit.
Generally, the areas being examined, using the TAM’s analysis, relate to the following issues:
- Is the dealership a reseller or producer? Based on the TAM, the dealership could be found to be a producer because of the service work it performs on its own new and used vehicles. If so, the required capitalized expenses are much greater.
- Are fleet, Internet, dealer trades, and lease sales considered retail sales, or are these wholesale sales that push the dealership over the 10 percent threshold?
The TAM has no technical authority, so the positions put forth have no teeth yet, Duffner says. However, according to Harris, there’s a pending revenue ruling being considered by the Treasury Department that will put authority into the conclusions reached in the TAM. She indicated in the Webinar that she didn’t know if the ruling will be issued soon; it has been pending since the beginning of 2008.
Accounting method changes
Harris is asking dealers to change their accounting methods (
Form 3115). At this time, it also appears certain accounting method changes filed related to the “producer issue” would be considered a non-automatic method change. Thus, they would subject to a higher level of scrutiny by the Treasury and require payment of the applicable user fee.
“Theoretically, the IRS is asking auto dealers to file non-automatic method changes based on opinions and conclusions of the IRS presented in a TAM, which has no technical authority,” Duffner says.
“We recommend dealers hold off on filing any 3115s until the pending revenue ruling is released and additional guidance is provided for the 3115 procedures (automatic vs. non-automatic),” Duffner says. “As strange as it sounds, filing a 3115 now, based on the existing guidance, is virtually impossible since many questions remain unanswered regarding how to make the actual calculation.”
If a revenue ruling is issued before the end of 2009 or prior to filing your dealership’s 2009 tax return, you may need to reconsider your filing position for UNICAP and potentially file an accounting method change on Form 3115.
Possible help from NADA
NADA has been working to educate the IRS on how dealers feel
UNICAP should be applied to the industry, but at this point, consumer finance initiatives for floor plan lending is the association’s top priority. NADA is determining the best place to spend member dollars on this matter as numerous meetings with the IRS have not changed its position.
The question remains whether NADA will elect to pursue the matter through the court system by selecting one of the various UNICAP exams for litigation, or by spending lobbying dollars to effect or propose new legislation through Congress. The AICPA is also expected to weigh in on the complexities of retailer UNICAP, but not specifically on behalf of auto dealers.
For more information, contact Jason Duffner at jduffner@larsonallen.com or 314-336-3665, or Dave Wiggins at dwiggins@larsonallen.com or 314-336-3816.