Tax Win for Dealers: IRS’s Position on UNICAP Doesn’t Stick
After a number of delays, the IRS made a favorable decision on how the uniform capitalization rules under IRC Section 263A (UNICAP) should be applied to auto dealers. On November 9, 2010, the agency issued two safe harbor accounting elections dealers can use so they don’t have to capitalize certain costs related to carrying and storing inventory.
“This new revenue procedure is a huge relief because it significantly limits the application of earlier guidance from the IRS, which could have cost car dealers thousands of dollars in additional taxes,” says Dave Wiggins, a dealership principal with LarsonAllen.
“This is an excellent first step towards bringing logic back to the taxation of dealerships. The UNICAP position the IRS was asserting just didn’t make sense,” he says.
The IRS’s former position would have required dealers to take large amounts of common expenses and add them to inventory at year-end, and that would have significantly increased taxable income for every dealership in the United States.
Many taxpayers never followed the proposed methodology in computing UNICAP because it was complex and they strongly disagreed with the IRS, according to Wiggins.
How the safe harbor elections work
Revenue Procedure 2010-44 makes two safe harbor elections available. The first option allows a dealership to treat its entire sales facility as a “retail sales facility.” The 2007 Technical Advice Memo (TAM) guidance required many dealerships to be treated as dual-function facilities and required a portion of the operating costs of the facility to be added to inventory, which delayed deductions and increased taxes. As a qualifying retail sales facility, these costs are fully deductible. Storage facilities that are separate from the main dealership do not qualify for this safe harbor, and operating costs related to those facilities must still be capitalized.
The second safe harbor allows a dealership to be treated as a reseller without production activities. The TAM guidance forced dealers to treat many inventory reconditioning activities as production activities, which not only required more direct cost capitalization but also limited the availability of simplified calculation methods.
These UNICAP rulings will apply to the following types of retail dealerships: new and used automobile, light, medium, and heavy duty truck, boat, RV, motorcycle, farm implement, and construction equipment dealers.
Background on UNICAP
Over the course of many years, the IRS has been investigating the various issues surrounding auto dealer UNICAP, which it believed represented the highest non-compliance risk in the industry.
During a 2006 dealership audit by the IRS, an auditor determined that the method used to calculate capitalized costs was invalid. The auditor requested national IRS involvement and subsequently issued a TAM to the taxpayer summarizing the position the service would take on the audit. The TAM effectively agreed with the auditor.
The position taken by the TAM invalidated use of the simplified retail method for the dealership. It also required a substantially higher capitalization of expenses for the dealership.
Next steps
The two new safe harbors will not end uniform capitalization, but they should reduce the risk of major audit adjustments resulting from differences between dealer and IRS calculations.
These accounting methods are elected with the filing of a Change in Accounting Method (Form 3115) with your 2010 dealership corporate tax return.
Your LarsonAllen tax advisor can help you decide whether to use one or both safe harbor accounting methods under the revenue procedure.
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Dave Wiggins, Dealership Principal
dwiggins@larsonallen.com or 314-925-4316
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