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Motor Vehicle Industry Overview - Significant Issues - June 2004

Affected IRM: X.XX.X

"This document is not an official pronouncement of the law or the position of the Service and cannot be used, or cited, or relied upon as such."

Significant Law and Important Issues

A. Coordinated Issues

IRM section provides that Coordinated Issues are binding on all IRS examiners and any deviation from the position stated in the Coordinated Issue papers must be discussed with the Technical Advisor.



Issue Description:

Dollar Value LIFO
Definition of an Item

For purposes of an inventory of motor vehicles, an item of LIFO inventory is defined by reference to:

  • Make
  • Year
  • Model
  • Body style
  • Standard equipment
  • Options, and other factors.
  • Adjustments should be made to the cost of the vehicles on hand at the end of the prior taxable year to account for as many of the factors as possible.
  • Safe harbor simplified methods are available in Revenue Procedure 92-79, The Alternative LIFO Method for new vehicles and Revenue Procedure 2001-23, Used Vehicle Alternative LIFO method. The coordinated issue still applies to taxpayers that have not elected the safe harbor and to all dealers in heavy equipment, farm equipment, and medium and heavy-duty trucks.
    • Coordinated Issue date: July 1998; 
    •   Settlement Guidelines: June 1993

Remanufacturers’ Inventory of Cores

Remanufacturers must value their inventory of cores for tax purposes at cost unless they substantiate a lower inventory valuation in accordance with the provisions of the regulations.

  • The remanufacturer’s “core charge,” “core deposit,” or other similar amount generally represents the cost and market of a remanufacturable core.
  • A safe harbor accounting method, The Core Alternative Valuation Method (CAV), was offered in Revenue Procedure 2003-20.  As a result, many taxpayers will be required to cease valuing the inventory of cores at zero or scrap.
    • Coordinated issue date: September 1989; 
    • Settlement Guidelines: August 1993

Excess Parts Inventory

Any excess parts that have been transferred to a warehousing company are includible in inventory when the taxpayer retains dominion and control over the parts.

  • Surplus and obsolete material transferred at a loss as part of a purported sale to an unrelated warehouse facility in prior years that are now closed by the statute of limitations constitute inventory for the current year when the taxpayer has retained dominion and control.
  • If the parts have been excluded for a number of years, a catch-up adjustment should be made to include them in the current year's inventory.
    • Original Coordinated Issue Date: September 1989,
    •  Revised 1998;
    •  Settlement Guidelines: August 1993  

Service Technicians’ Tool Reimbursements

Whether amounts paid to motor vehicle service technicians, as tool reimbursements meet the accountable plan requirements of IRC §62.  

  • If the facts and circumstances indicate that amounts are paid under a non-accountable plan, IRC §62 and the accompanying regulations require that the amounts must be:
  •   Included in the employee’s gross income
  • Reported on Form W-2
  • Subject to the withholding and payment of employment taxes.
    • Coordinated Issue Date: July 2000

B. Significant Issues

The Motor Vehicle Technical Adviser is currently developing the following issues.  Although in some cases clear guidance exists; the issue remains an area of non-compliance within the industry.  Other issues require further development of the facts and circumstances to determine the proper treatment of the item.  The facts and circumstances of each issue must be evaluated and the applicable law must be applied as appropriate to the facts.


Brief Summary of Issue:

Auto Dealership Software Programs

Issue:  Whether computer systems used by automobile dealerships to generate financial and accounting data satisfy the record retention and accessibility requirements of Revenue Procedure 98-25.

  • Dealership computer systems generally do not retain data for a sufficient period nor does the system generate data in sufficient detail.
  • Typically, dealerships use proprietary software that does not allow access by IRS computer audit specialists. 
  • Revenue Procedure 98-25 provides the record retention requirements for taxpayers that utilize an electronic data processing system.
  • Scope of the Issue:
    • Due to the requirements imposed by automobile manufacturers, the issue potentially affects the entire body of franchised dealerships (in excess of 22,000 dealerships
  • Applicable Rulings and Cases
    • Revenue Procedure  98-25

Capital Cost Reduction (CCR)

Issue:  Whether the capital cost reduction payment (CCR)   or the first monthly lease payment made by a lessee is income to the purchasing company (frequently the finance subsidiary of a motor vehicle manufacturer or distributor), or a reduction in the basis of the leased vehicle on the books of the purchaser.

  • Vehicle lessees often reduce their monthly lease payments by making a capital cost reduction (CCR) payment. Further, lessees are often required to make the first monthly payment on the lease up front.
    • The dealership generally retains the CCR and first monthly lease payment.
  • The vehicle is then transferred to a leasing company for an amount negotiated between the dealership and the leasing company.
  • The leasing company remits to the dealership the difference between the negotiated selling price less the CCR and first month’s rental payment.
    • Status: Rev. Proc 2002-36 allows the purchaser to treat the CCR payment and the first monthly payment as reductions to the basis of the leased vehicle. However, lease acquisition fees should still be included in the taxable income of the leasing company.   Further, Rev. Proc. 2002-36 holds that the treatment of the CCR and first monthly lease payments by the leasing company is a method of accounting, and any change to this method must be made prospectively by filing a Form 3115.
    • Advice: Ensure that your taxpayer is including lease acquisition fees in taxable income. Contact the Motor Vehicle Technical Advisor if you receive a claim with respect to CCR or first monthly lease payments.

Dealer Participation

Issue:  Whether dealer participation paid by an automotive finance company to a dealer on the acquisition of a retail installment sales contract (RISC) or lease should be capitalized and amortized.

  • When a dealer sells/assigns a RISC or lease contract to a purchaser (often an automotive finance subsidiary), that carries a contract interest rate that is greater than the purchaser’s buy rate, the dealer receives dealer participation, also known as dealer finance income, from the purchaser. 
  • FSA 200217025 (April 26, 2002), holds that dealer participation paid to acquire RISCs is subject to capitalization and is not treated as a currently deductible transaction cost. The FSA does not address how the capitalized dealer participation should be amortized, nor does it address whether dealer participation paid on the acquisition of a lease should be capitalized and amortized. Further, the FSA was issued prior to the time the final 263(a) regulations on the capitalization of  costs to acquire certain intangibles were published.   
  • Advice:  The final 263(a) regulations (2003 TNT 246-4) were published at the end of 2003. The MVTA intends to seek out cases for which published guidance can be requested  (Technical Advice) that will address this issue.   What does this mean to you if you have the issue? You should contact either Sharon Russell, the Capitalization TA.

Demonstrator Autos

Issue:  Whether demonstrator vehicles provided to dealership employees qualify as excludible working condition fringe benefits.

  • If the use of a demonstrator vehicle does not qualify as a working condition fringe benefit, the fair market value of the use must be included in gross income.
  • To exclude the value of demonstrator vehicles provided to dealership sales employees, the dealership must satisfy the detailed substantiation requirements of IRC §274, in addition to other requirements.
  • Dealers may not use the lease value rules to determine the fair market value of demonstrator vehicles unless it properly elects the method and complies with all requirements.
  • Scope of the Issue:
    • Potentially affects all new and used car dealerships (in excess of 22,000 dealerships).
  • Applicable Rulings and Cases
    • Technical Advice Memoranda and Private Letter Rulings
      • 9801002
      • 9840015
      • 9816007
      • 9522002
  • Court Rulings
    • BMW of North America, Inc. 83 AFTR2d Par. 99-413
  • Revenue Procedure
    • 2001-56

Extended Service Contracts

Issue:  What is the proper method of reporting proceeds from the sale of extended service contracts, payments for the purchase of insurance policies, and amounts remitted to an administrator, escrow account, or producer owned reinsurance company (PORC)?

  • Dealers, manufacturers, or other parties sell extended service contracts as an “agent” or as the “obligor” or “principal” on the contract.
  • If the company is the agent it must: 
    • Accrue commission income in year sold.
  • If the company is the obligor or principal and it purchased insurance to cover its risk it must: 
    • Include the full selling price of the contract in income in the year the contract is sold. 
    • Amortize the cost of insurance over the life of contract.
  • If the company is the obligor and it purchased insurance from an unrelated company to cover its risk, it may:
    • Elect the Service Warranty Income Method (SWIM).
      • The company includes the qualified advance payment amount in income over the life of the contract.
        • Qualified Advance Payment Amount  
          • The amount of the sales proceeds that equals the payment for insurance plus an “interest” factor added in.
  • If the company is the obligor or principal and it enters into an agreement whereby some portion of the funds are deposited into an escrow or trust account, the company might: 
    • Purchase Stop loss insurance.
    • Pay Administrator fees.
    • The dealership or its designee might receive unconsumed reserves.
  • If the company is the obligor or principal and it enters into an agreement whereby some portion of the funds are deposited into an escrow or trust account, the following applies:
    • Investment income earned by the escrow or trust account must be reported as income by the dealership.
    • Sales price of contract is income to the dealership when the contract is sold. 
      • Claims are deductible when paid.
      • Administrator fees are deductible as economic performance occurs.
      • Stop loss insurance costs must be amortized.
  • Scope of the Issue:
    • Potentially affects all franchised new vehicles dealerships, used car dealerships, dealers in motorcycles, boats and equipment, insurance companies, and financial institutions.  Similar issues may exist in other industries.
  • Applicable Rulings and Cases
    • Rev. Procedures:
      • 92-97
      • 92-98
      • 97-36
    • Technical Advice and Private Letter Rulings:
      • 7921048
      • 9218004
      • 9225003
      • 9251007
      • 9417028
      • 9601001
      • 9727014 
    • Court Rulings:
      • Hinshaw’s Inc. T.C. Memo 1994-327
      • Schulde v. Commissioner 372 U.S. 128
      • Rameau A. Johnson, 84AFTR2d Par. 99-5073 and 108 T.C. No.22
      • Toyota Town, Inc. T.C. Memo 2000-40
      • Appeal Filed  (Bob Wondrias Motors)
      • Affirmative Issue Raised – Dealers were only “agents”.
      • Department of Justice Brief filed  - 2000TNT 202 10/18/00

Interest Rate Subvention Payments

Issue 1:  What is the proper tax treatment of interest rate support payments (subvention payments) made by an automobile manufacturer to its wholly owned finance subsidiary in the following circumstances?:

  1. The interest rate subvention payments are made in connection with the acquisition of below-market rate  retail installment sales contracts (RISCs) and leases. 
  2. The subvention liability is accrued by the parent but payments are deferred and made to the finance subsidiary over the life of the RISC or lease.

Issue 2:  Is the subvention transaction a method of accounting or a method of reporting?

Issue 1 Status: Following the Tax Court’s decision in General Motors v. Comm., 112 TC 270 (1999), the 1995 consolidated return intercompany transaction regulations, and   TAM 200302002, subvention payments made by a manufacturer or distributor to it’s wholly-owned finance subsidiary are deductible in the year paid. Further, subvention payments received by the finance subsidiary reduce the basis of the RISC, or, in the case of a lease, reduce the basis of the leased vehicle. The finance subsidiary includes the subvention payment in taxable income over time as the retail customer makes its payments. Still at issue is whether the manufacturer or distributor can currently deduct its accrued subvention liability under Section 461 before it actually makes the subvention payment to the finance subsidiary.

Issue 2 Status: The issue here is whether the subvention payment transaction is a method of accounting, or a method of reporting , that does not require the Commissioner’s consent to change. This is a factual determination. Following the GM Tax Court decision, many industry taxpayers filed claims to either reverse the deferral of the manufacturer’s subvention deduction or to reverse the finance subsidiary’s current inclusion of the subvention payment in its taxable income. Those taxpayers that made the reversals on their tax returns as “consolidated return adjustments” similar to the adjustments made by GM have generally had their claims allowed. The Tax Court determined that these adjustments are changes in methods of reporting consolidated taxable income and consent to change was not required. But those taxpayers who made their reversals as part of their separate method of accounting, where the facts differ from GM, have had their claims denied. See for example, TAM 200302002. This issue generally applies to claims filed for tax years prior to 1996.  After 1995, the revised  consolidated return regulations define this as an intercompany transaction, and state that all intercompany transactions are considered methods of accounting.

Advice: 1) What if your taxpayer claims a deduction under section 461 when it accrues the subvention liability but defers payment over time, or 2) What if you receive a claim for subvention that spans both pre-1996 and post-1995 tax periods? You should contact the Motor Vehicle Technical Advisor for advice. Both of these issues are currently being considered by Appeals. 

Like Kind Exchange

Issue:  Whether the transfers of lease vehicles followed by the acquisition of replacement vehicles are deferred exchanges, each qualifying for non-recognition of gain or loss under section 1031.

  • Taxpayer’s vehicle leasing operation was restructured with the intent that the disposition of a vehicle coming off lease by the company to an unrelated party and the acquisition by the company of a lease vehicle recently acquired from a dealer will qualify as a like-kind exchange under section 1031. 
  • Taxpayer entered into an agreement with a qualified intermediary (QI) and assigned its rights for the sale of relinquished vehicles and the purchase of replacement vehicles to the QI 
  • Status: Recent letter rulings -- similar facts:
    • LTR 200240049 (2002 TNT 195-41)
    • LTR 200241013 (2002 TNT 199-40)
    • LTR 200242009 (2002 TNT 204-23)

IRS ruled in all three that the transfers of vehicles, followed by the acquisition of replacement vehicles are deferred exchanges, each qualifying for non-recognition of gain or loss under section 1031.

Advice: The above rulings were obtained by banks. The like kind exchange issue is currently being examined on several industry cases. Please contact the Motor Vehicle Technical Advisor if you have this issue on your examination.

Mark to Market

Issue:  What is the proper valuation method to use in determining the fair market value of motor vehicle finance securities for purposes of Section 475, mark to market (MTM)?

Background: A number of industry taxpayers are engaged in the business of acquiring retail installment sales contracts (“RISCs”) from independent dealerships covering the sales of motor vehicles to the dealership’s customers.  Generally, motor vehicle manufacturers and distributors establish a captive finance subsidiary whose principal purpose is to acquire the RISCs from the independent dealers.  These taxpayers are considered (or can elect to be considered) dealers in securities, and consequently, the RISCs are debt instruments under section 475(c)(2)(C) and are subject to the mark-to-market provisions. 

Status: On April 30, 2003, an Advance Notice of Proposed Rule Making was published that describes and explains a possible safe harbor that would satisfy the MTM valuation requirement for certain securities and commodities (REG -100420-03). The ANPRM does not change the Service’s position with respect to this issue as it is currently illustrated in Bank One Corp. v. Commissioner, (120 T.C. No. 11).Accordingly, John Petrella, Director, Heavy Manufacturing and Transportation, has directed that current audits involving the section 475 MTM valuation issue should proceed in the same manner as before the ANPRM was issued., and no published guidance will be issued by the Service until the proposed regulations are finalized.

Advice: What does this mean to you if you have the issue? You should contact either the Section 475 Technical Advisor, Suzanne Boule, or the Motor Vehicle Technical Advisor. They are both currently working closely with the Financial Products Specialists that are developing MTM valuation methodologies on a number of industry examinations. Because these methodologies involve complex economic and finance principles, they are beyond the scope of this guide. Further, the MTM issue is affected by both the subvention issue and the securitization issue, so it is important to coordinate the development of all three issues.

Parts Inventory

Issue:  How can a taxpayer to value parts inventory?  A taxpayer can use replacement cost to value parts inventory.

  • Revenue Procedure 2002-17
  • Producer Owned Reinsurance Companies (PORC)

Producer Owned Reinsurance Companies (PORC)

Issue:  Do transactions with a Producer Owned Reinsurance Company (PORC) qualify as arms length transactions or is the PORC as sham corporation?

  • Typically, an automobile dealership owner or shareholder forms a reinsurance company to reinsure extended service contracts and/or credit life insurance sold by a related automobile dealership.
  • PORCs are generally:
    • Formed offshore in locations such as the Turks and Caicos Islands, Bermuda, Nevis Island, etc.
    • Minimally Capitalized
  • Funds typically remain within the U.S.
  • A dealership sells “dealer obligor” extended service contracts and insures its risk by purchasing a contractual liability policy from an unrelated insurer or “fronting company.”
    • The fronting company transfers the risk and the premium, less a ceding fee, to the related PORC.
  • The PORC might:
    • Elect to be taxed as U S Corporation.
    • Apply special life insurance company rules.
    • Assert tax exempt status applicable to some casualty companies.
  • Potential Issues:
    • Improper application of insurance company rules.
    • Improper application of tax exempt rules.
    • Inadequate risk shifting and risk distribution.
    • Sham transactions.
    • Undercapitalization
    • Indemnification of ceding insurer.
    • Non-performing loans.
    • Dividends.
    • Commission shifting arrangements – credit life.
  • Scope of the Issue:
    • Potentially affects new car and used car dealerships,dealers in equipment and other motor vehicles, motor vehicle manufacturers, insurance companies, administrators, and financial institutions.
  • Applicable Rulings and Cases
    • Revenue Rulings:
      • 77-316
      • 89-61
      • 88-72
      • 92-93
    • Technical Advice Memoranda
      • 9729002
    • Court Rulings:
      • William Wright T.C. Memo 1993-328
      • Malone and Hyde, Inc. 76 AFTR2d Par. 95-5250
      • William L. McCurleyT.C. Memo 1997-371
  • Notices for Listed Transactions
    • Notice 2002-70 (Disclosure required)

R & E Credit


Whether the manufacturer or supplier (or both) is entitled to the research credit when the manufacturer requires the supplier to develop all or part of a component, subsystem, or production process.

  • Manufacturers are increasingly requiring suppliers to become more involved in the engineering and design of automotive components, subsystems, and production processes.
  • Suppliers may conduct research and manufacture prototype parts that will eventually be mass-produced, or processes that will be used in the mass production of parts
  • The manufacturer may reimburse the supplier for at least a portion of the costs but typically, reimbursement is received on a piece-part basis under the terms of a parts supply agreement.

Potential issues:

  • Several parties may be incurring research costs for the development of the same components, subsystems, and processes, and there may be a duplication of the research credit.  
  • Records tying research costs to specific projects may not be maintained.
  • All applicable tests must be considered to decide if the item or activity constitutes qualifying research activity for purposes of IRC §41. 
  • In determining who is entitled to take the credit several factors should be considered:
    • Who is bearing the costs?
    •  Who is bearing the risk?
    • How and when is reimbursement received?
    • When is risk shifted?
    • On what amounts should the credit be computed?

Scope of the Issue:   Potentially affects all motor vehicle manufacturers and suppliers.

Related Finance Company (RFC)

Whether transfers of vehicle finance contracts from the selling dealership to a related finance company are arms length transactions or whether the RFC is a sham corporation.

  • Dealerships frequently provide financing to vehicle purchasers that are unable to obtain financing through traditional channels.
  • Subsequently, the dealership transfers the contracts to a finance company related to the dealership (RFC).
  • Analysis of the substance of the transfer is required to determine if a sale occurred.
  • Some transfers are not arms-length and lack economic substance.

Scope of the Issue:  Potentially affects all used car dealerships and allows dealerships to reduce income or defer the reporting of income in a manner not contemplated by the tax statute and rules.

  • Applicable Rulings
  • Technical Advice Memorandum 97404002

Replacement Cost LIFO  

Whether the use of replacement cost in valuing a LIFO inventory complies with the regulatory requirements to value LIFO inventory at cost.  

  • The Regulations require a taxpayer that elects the LIFO method of accounting to use actual cost in determining its LIFO inventory value.   
  • Dealerships and parts retailers and wholesalers typically maintain a large inventory of parts and accessories. 
  • Periodically, the manufacturer provides a price list that includes the manufacturer’s current price for each part. 
  • Taxpayers maintain computerized recordkeeping systems that include the part number and the quantity of parts on hand in each category. Actual cost of the parts is not included. 
  • Following standard industry practice, the value of the parts inventory is calculated using the inventory quantity on hand at year end and the price for each part as provided in the current manufacturers’ price list (replacement cost). 
  • The courts have ruled that:   
  • Replacement Cost Does Not Clearly Reflect Income.
  • Cost is Actual Cost
  • Termination of LIFO is Appropriate. 
  • Acting Commissioner Tom Wilson issued a memo on June 23, 1999 requiring all open examinations of replacement cost LIFO be coordinated through the Motor Vehicle ISP.
  • Scope of the Issue:
  • Potentially affects all dealerships on the LIFO method of accounting.  Issue also may be present in other industries with a large inventory of small items.  As of May 2000, potential resolutions strategies provided by industry representatives were being evaluated.
  • Applicable Rulings and Cases
  • Technical Advice Memoranda 9443004 & 8906001
  • Court Rulings:
  • Mountain  State Ford Truck Sales, Inc. 112 T.C. No. 7 (Appeal filed 2-24-00)

Securitization of Auto Receivables

Whether the securitization of automotive retail installment sales contracts (RISCs) should be treated as a sale or a secured financing.

  • If a securitization is treated as a sale, then the taxpayer is treated as having retained an ownership interest in the RISCs sold, and a portion of the basis of the RISCs is allocated to the amount retained under section 1286, resulting in a taxable gain. Deferred costs such as dealer participation, and selling expenses are deductible at the time of the sale. Deferred subvention income is recognized. On the other hand, if a securitization is treated as a secured financing, then no gain is recognized, deferred costs continue to be amortized, selling expenses are capitalized and amortized, and subvention income continues to be deferred and amortized. For mark-to-market purposes, securitized RISCs continue to be subject to mark-to-market at the election of the taxpayer if the securitization is treated as a secured financing.

Status: Currently the only published guidance with respect to automotive RISC securitizations is LTR 9839001 (see below under Section F). 

Advice: What does this mean to you  if you have the issue? You should contact either Technical Advisor Tim Taggart or the Motor Vehicle Technical Advisor. 


Whether the direct and indirect costs incurred to remove a competitor’s stock and replace the merchandise with the stocklifting company’s products are currently deductible or whether the costs must be capitalized.

  • Manufacturers and wholesalers may expand their business by “lifting the stock” of a competitor’s products and replacing them with their own parts. 
  • The company gives the new customer full credit to be used against future purchases from the new supplier.
  • The “lifting” company then either repackages and sells the products or scraps them.
  • Costs incurred in a stock lift are substantial and each stock lift is economically feasible only if the customer continues to purchase parts from the new supplier for several years.

Advice: The final 263(a) regulations on the capitalization of intangibles contains an example addressing the treatment of stocklifting costs (2003 TNT 246-4; 1.263(a)-4(l) Example 8). Generally, if the new customer is under no obligation to continue stocking the manufacturer’s or distributor’s parts, then capitalization is not required for the stocklifting costs. The final regulations were published at the end of 2003.

Sub Prime Financing

What is the proper tax treatment of the transfer of sub-prime and/or non-prime vehicle finance notes from the selling dealership to an unrelated finance company?

  • Dealerships frequently provide financing for vehicle purchasers that are unable to secure financing on their own.
  • The contract is subsequently transferred to an unrelated finance company.
  • The dealer receives a portion of the agreed upon price (typically 50% of the note) upon transfer.
  • The finance company pays the dealership additional amounts based on collections (backend distributions) if certain conditions are met.
  • Based on the fact and circumstances of each case and applying the reasoning found in the related rulings, generally:
  • The transaction might qualify as a sale, not an assignment of the contract or a loan.
  • If the transfer is deemed to be a sale, the amount realized from the transfer is equal to the cash received plus the fair market value (FMV) of the right to receive back end distributions.
  • FMV of backend distributions must be determined
  • Backend distributions are contingent and must be recharacterized into principal and interest.
  • New and Emerging Scenario:
  • Finance contracts are transferred at 100 percent of book value
  • All parties treat the transaction as a sale
  • Scope of the Issue:
  • Potentially affects all new and used car dealerships, finance companies, motor vehicle manufacturers, and financial institutions.
  • Applicable Rulings
  • Technical Advice Memoranda:
    • 8940001
    • 199909003
    • 199909002

Used Car Write-down

Whether a vehicle dealership that elected the Lower of Cost or Marketing method of accounting can reduce the value of its used car inventory at year-end.

  • Based on the facts and circumstances of each case and the application of existing rulings to the facts generally:
  • Dealerships can value a used vehicle taken in trade at a cost determined by reference to an official used car guide.
  • Purchased vehicles must be valued at actual cost, i.e. purchase price.
  • Substantiated write downs may be allowable
  • Dealerships that elect the LIFO method of inventory valuation may not write down vehicles.
  • Scope of the Issue:
  • Potentially affects all new and used car dealerships.
  • Applicable Rulings:
  • Revenue Ruling: 67-107
  • Technical Advice Memoranda:  8906001
  • Cases: Best Auto Sales T.C. Memo 2002-297 

Used Car LIFO


What is the proper method of computing LIFO for used vehicles?

Based on the fact and circumstances of each case and applying the reasoning found in the related rulings, generally:

  • To calculate the used vehicle LIFO index, the dealer must compare vehicles based on age i.e. compare the vehicle in the current year’s ending inventory to the previous model year’s vehicle. 
  • Adjustments for options, mileage and vehicle condition might need to be made to the prior year’s vehicle to insure that like items are compared.
  • Prior year costs can be reconstructed by reference to an official used car guide.
  • The cost of a vehicle in ending inventory must be compared to the cost of a similar vehicle 52 weeks prior to its acquisition.
  • Scope of the Issue:
  • Potentially affects all new and used car dealerships
  • Applicable Rulings and Cases
  • Technical Advice Memoranda:  9853003
  • Revenue Rulings 97-37, 98-60
  • Taxpayer can elect Alternative Used Car LIFO 
    • Revenue Procedure 2001-23 

C.  Important Revenue Rulings or Revenue Procedures


Effective Date

Title and Number

Summary and Impact of Ruling and Procedure

Release Date:  February 10, 2003

Revenue Procedure 2003-20

Core Alternative Valuation (CAV)


  • The CAV safe harbor method applies to remanufacturers, rebuilders and resellers of motor vehicle parts that use the lower of cost or market inventory method.

Release Date: April 1, 2002

Revenue Procedure 2002-17

Parts Inventory


  • Taxpayer can use replacement cost to value used parts inventory.

Release Date: May 28, 2002

Revenue Procedure 2002-36

CCR Payments


  • Provides purchasers of auto leases with a safe harbor method of accounting for CCR payments, under which the CCR payment and the first monthly rental payment   made by a lease customer is excluded from the purchaser’s taxable income but reduces the depreciable basis of the vehicle subject to the lease.  Lease acquisition fees are excluded from the safe harbor and must be included in taxable income. Requires consent to change method of accounting.

Release Date: June 17, 2002


Revenue Procedure 2002-42

Clean-Fuel vehicle property


  • Allows a taxpayer who purchases certain clean-fuel vehicle property to rely on a manufacturer’s certification of the incremental cost of the property for purposes of the clean-fuel vehicle property deduction under Code Section 179A.

Release Date:  November 25, 2002

Revenue Ruling 2002-67

Car Donations


  • The donor’s transfer of a car to a charity’s authorized agent may be treated as a transfer to the charity.

Effective for tax years ended on or after December 31, 2000

Revenue Procedure 2001-23

Alternative LIFO for Used Vehicle Dealers


  • A simplified method of computing LIFO available to dealers of used vehicles and used light trucks.
  • An elective, link-chain method encompassing several special rules and required sub-methods.
  • LIFO indexes are computed using base prices from an “official used vehicle guide.”
  • Guidelines are provided on how to determine current year cost of vehicles in ending inventory.

Indexes are then applied to the value of the ending inventory at current year cost to determine whether an increment or decrement has occurred.


September 28, 1992

Amended and superceded August 18, 1997

Revenue Procedure  97-36

(Previously Revenue Procedure 92-79)

Alternative LIFO for automobile dealers.  


  • Provides a simplified LIFO method for dealers in cars and light duty trucks and waives strict adherence to the comparability requirements of Treas. Reg. 1.472-8.

Release Date:  September 25, 1997

Revenue Ruling


LIFO Conformity


  • No method other than LIFO can be used in financial statements provided to shareholders or creditors.
  • R.R. 97-42 provides examples of non-conforming and conforming financial statements.

Release Date:  September 25, 1997

Revenue Procedure 97-44

LIFO Conformity-settlement provisions


  • Provided a settlement procedure whereby automobile dealerships conducted a “self audit” to determine whether they had previously issued non-conforming financial statements to the manufacturers’ captive finance companies.
  • Dealerships found to have issued non-conforming statements paid an amount equal to 4.7 percent of the LIFO reserve.

Release Date:  September 8, 1998


Revenue Procedure 98-46

LIFO Conformity-settlement provision extension


  • Extends the LIFO conformity settlement provisions of Revenue Procedure 97-44 to medium and heavy-duty truck dealerships.

Effective Date: June 12, 1992


Revenue Procedure 92-98

Elective procedure to report income from the sale of extended service contracts-Service Warranty Income Method (SWIM)


  • Allows auto dealerships that sell certain dealer obligor extended service contracts and that met specific criteria to defer the qualified advance payment amount using the Service Warranty Income Method (SWIM).

Release Date:

July, 1972

Revenue Ruling 72-326

Proper accounting for payment of “holdback” amounts received by a dealership from the manufacturer


  • Holdback charges included in the manufacturer’s invoice price of motor vehicles may not be included in cost of goods or claimed as a deduction by the dealer.


Revenue Ruling 84-41

Inventory Values and Rebates                  


  • An automobile dealer must record the cost of new automobiles in inventory reduced by the amount of a manufacturer’s rebate which represents a trade discount.

Release Date:

January, 1970

Revenue Ruling 70-337

Proper treatment of incentive payments received by dealership employees from manufacturer.

(Note: The payments considered by this issue are not the incentives or rebates paid by the manufacturer to the dealership based on the dealership’s performance.)

  • Incentive payments paid by a manufacturer to dealership employees are not remuneration for services performed for the dealership.

§         Amounts are compensation for services performed for the manufacturer.

  • Payments are not wages and not subject to employment taxes.
  • Publication 3204 issued outlining proper reporting.

D. Important Court Cases


Date Opinion Issued  

Court Case


December 2, 2002

Best Auto Sales;  T.C. Memo 2002-297

Used car write downs


  • Without objective evidence such as records to substantiate item-by-item comparisons of cost of market value, a taxpayer’s value estimates could not provide a basis for allowing the inventory write-downs.

February 11, 1999

BMW of North America, Inc.; 83 AFTR2d Par. 99-413

U.S. District Court granted partial summary judgment to the Government.
BMW cannot use the special valuation rules to determine the fringe benefit value of BMW cars provided to its employees.
BMW improperly applied the rule.

June 22, 1959

Commissioner vs. Hansen; 360 U.S. 446

Amounts credited to an automobile dealership in a reserve account on the books of the finance company must be reported as income during the tax year in which the amounts are credited to the reserve accounts.

July 20, 1998

Consolidated Manufacturing, Inc.; 111 T.C. No. 1

LIFO must be elected for an entire “good” and not a portion of the goods such as labor and overhead.
For remanufacturers, cost and market equal the core amount shown on the invoice corresponding to the remanufactured part.
The Court supported the IRS authority to terminate an improper LIFO election.

May 26, 2000

Esobar de Paz. V. Commissioner, T.C. Memo 2000-176

All amounts paid to employees for transporting cargo in employee-owned trucks were wages.  The employees were not engaged in two separate activities of leasing trucks to their employer and driving the trucks.

August 12, 1996

E.W. Richardson; T.C. Memo 1996-368 T.C. Memo 2000-176

An auto dealership made an unauthorized change in method of accounting when it changed its definition of a LIFO inventory item from “vehicle body size” to “model line.”
The decision reaffirmed that the definition of an item for LIFO inventory is a method of accounting and that taxpayers must apply the method consistently.

  • See - Richardson Investments, Inc . 76 T.C. 736

May 11, 1981

Fox Chevrolet, Inc.;  76 T.C. 708

Two separate pools are required for purposes for new car LIFO.
New automobiles. 

July 18, 1994

Hinshaws, Inc. T.C. Memo 1994-327

Auto dealerships must report collections for vehicle service contracts as gross income in the year received.

July 7, 1997

Howard Pontiac GMC, Inc.; T.C. Memo 1997-313

The Tax Court “split the baby in half” ruling that neither the taxpayer nor the Government properly valued a covenant not to compete.

January 24, 2000

Leb’s Enterprises, Inc.; 85 AFTR2d Par, 2000-450

U.S. District Court granted summary judgment to the Government.
Drivers that transported vehicles from place to place were employees of the company.
Company was responsible for applicable employment taxes.

August 18, 1995

Malone and Hyde, Inc; 76 AFTR2d Par 95-5250

Payments by a parent corporation to a subsidiary for “insurance” are not deductible.
Under capitalization or indemnification are important factors in determining whether a transaction is a sham.

March 2, 1999

Mountain State Ford Truck Sales, Inc.; 112 T.C. No. 7

For LIFO inventory purposes, taxpayers must use actual cost and not replacement cost.
The use of replacement cost does not clearly reflect income.
The IRS did not abuse its discretion by adding the taxpayer’s LIFO reserve back to income since the taxpayer failed to keep adequate records to compute LIFO using any other method.
Case applies to automobile dealerships, parts stores, and other taxpayers that use replacement cost in calculating LIFO for parts or other similar inventory. 

June 16, 1997; July 21, 1999

Rameau A Johnson, etal. 108 T.C. No.22; Affirmed 84AFTR2d; 99-5073

Auto dealerships must report income from sale of vehicle service contracts in the year sold.
Claims are deductible as incurred. 
Investment income on escrow accounts is income to the dealership.
Stop loss insurance must be amortized over the life of the contract.
Administrative fees can be amortized if the taxpayer can demonstrate a reasonable manner in which to estimate the amount (cost) and timing of administrative services.
If a taxpayer cannot so demonstrate, a deduction should not be allowed until the end of a contract.

May 11, 1981

Richardson Investments, Inc.; 76 T.C. 736

An automobile dealership could not use one pool consisting of new cars and new trucks, for LIFO purposes.
The Court determined that the dealership should use one pool for new cars and one pool for new trucks.
See E.W. Richardson T.C. Memo 1996-368

February 18, 1963

Schlude vs. Commissioner; 372 U.S. 128

Income is taxable to an accrual basis taxpayer when all events have occurred fixing the right to receive it.
Case is applicable to auto dealership extended service contract issues.

February 8, 2000

Toyota Town, Inc.; T.C.  Memo 2000-40

Automobile dealerships must amortize insurance premiums ratably over the term of the vehicle service contract.

June 2, 2000

Trans-Box Systems, Inc. v. United States, 84 A.F.T.R. 2d(RIA) 6479 (N.D. Cal. 1998) affd. 2000 U.S. App. LEXIS 12595 (9th Cir. June 2, 2000)

Amounts paid to employee drivers as reimbursements for mileage expenses were not paid pursuant to accountable plan.  Rejected plaintiff’s assertion that a substantial compliance rule applies to accountable plans.

June 7, 1979

Wendell Ford Sales, Inc.; 72 T.C. 447

The addition of a catalytic converter and a solid state ignition system did not make the 1975 Ford vehicle a different “item” for LIFO purposes than the 1974 Ford vehicle.

August 14, 1997

William L McCurley; T.C. Memo 1997-371

Distributions from a “shared” PORC are dividends to the individual.
Court noted that an auto dealership PORC may be a “cash cow” providing “tax-free and interest free” funds for shareholders.

July 26, 1993 Amended October 29, 1993

William Wright et al; T.C. Memo 1993-325 76 AFTR2d Par. 95-5805

Transactions between the dealership and the Producer Owned Reinsurance Company (PORC) were characterized as sham transactions. 
The PORC’s corporate form was disregarded and its income deemed received by the dealership owners.

E.  Technical Advice Memoranda and Private Letter Rulings






September 1989

LTR 8906001


  • New recreational vehicles should be pooled separately from new cars and new trucks.
  • Used cars and used trucks must be pooled separately.
  • The use of current replacement cost for valuing parts ending inventory is a non-cost-based inventory method.
  • Vehicle comparison must consider options and accessories. 
  • Trade-in values may be determined with reference to values listed in an official used car guide. 

April 1993

LTR 9332003


  • Beginning of the year costs of new items cannot be reconstructed using an annual LIFO index derived by excluding new items from the computation.
  • Dual index methods are not permissible.
  • Increment valuation should be based on costs incurred during the current year not costs incurred in the prior year.
  • Mini vans built on a car platform can be included in the dealership’s car pool.

August 1994

LTR 9433004

Replacement Cost LIFO

  • Replacement cost is an unacceptable method of valuing a taxpayer’s LIFO parts inventory pool.

June 1994

LTR 9435039

Luxury Tax – Sport Utilities

  • Sport Utility vehicles with a gross vehicle weight in excess of 6,000 pounds do not qualify as “passenger autos” and are not subject to the luxury tax.

August 1994

LTR 9448004

Equipment Leasing - Inventory

  • Ruling concluded that the equipment was properly includible in inventory.
  • Majority of the company’s income was generated from sales not leases.

January 1995

LTR 9522002

Demonstrator Vehicles

  • The inventory value of new demonstrator vehicles may not be written down at year-end.
  • The dealer replaces the demos with new vehicles and not the used cars listed in an official used car guide that the taxpayer used.

September 1995

LTR 9535005

LTR 9535006

LTR 9535007

Luxury Tax

  • A leasing dealership is responsible for collection of the luxury tax, not the finance company to which the dealership transferred the lease
    • The lease qualifies as the “first retail sale”
    • The lease acquisition fee relates to the lease transfer not the first retail sale and is not subject to the luxury tax.

January 1997

LTR 9704002

Related Finance Companies

  • Transfers of automobile finance contracts from an auto dealership to the dealership’s related finance company (RFC) are shams.
    • Transfers were not arms-length and lacked economic substance..

July 1997

LTR 9729002

Producer Owned Reinsurance Company

  • Payments made by an auto dealership through a “fronting’ insurance company to the dealer’s Producer Owned Reinsurance Company (PORC) were not deductible as insurance premiums.

May 1997

LTR 9746011

LIFO Recapture

  • Transfer of a dealership corporation’s LIFO inventory to a subsidiary did not trigger the recapture provisions of IRC 1363(d).

January 1998

LTR 9801002

Demonstrator Vehicles

  • To exclude the value of demonstrator vehicles provided to dealership sales employees, the dealership must satisfy the detailed substantiation requirements of IRC §274.
  • If the use of a demonstrator vehicle does not qualify as a working condition fringe benefit, the fair market value of the use must be included in gross income.
  • Dealers may not use the lease value rules to determine the fair market value of demonstrator vehicles unless it properly elects the method and complies with all requirements.

March 1998

LTR 9811004

Equipment Leasing - Depreciation

  • Equipment primarily held for lease can be depreciated rather than inventoried.

July  1998

LTR 9830001

Residual Value Insurance for Leases

  • A vehicle leasing company must amortize the cost of residual value insurance over the term of the vehicle lease.

September 1998

LTR 9839001

Transfers of Automobile Loans

  • Transfer of automobile loans to a trust was secured financing and not a sale.

October 1998

March 1999

March 1999

LTR 9840001

LTR 199909003

LTR 199909002

Sub-Prime/Non-Prime Financing

  • The transfers of customer notes from a used car dealership to an unrelated finance company are sales.
  • The dealer’s amount realized on the sale equals the cash received from the finance company plus the fair market value of the dealer’s right to receive future distribution payments.
    • The FMV of the future payments is not necessarily  $0.
    • The distribution payments are contingent and subject to the rules of IRC §483(f).
    • Each distribution payment must be allocated to principal and interest.

September 1998

LTR 9853003

Used Car LIFO

  • Used car dealership must reconstruct the beginning-of-the-year cost of an item by reference to:
    • The value of the previous year’s model
    • 52 weeks prior to the date the vehicle was acquired.
  • Dealership’s dual index method did not clearly reflect income.

September 1998

LTR 9893001


  • Based on the analysis of which party bore the risk of loss and which party had the potential for gain following the securitization of automotive retail installment sales contracts (RISCs) by an auto manufacturer, the IRS ruled that the securitization should be treated as a secured financing (debt) instead of a sale of the RISCs.

March 1999

LTR 199911044

LIFO Pooling for Auto Dealerships

  • Based on the specific facts and circumstances, a franchised auto dealership could maintain one inventory pool for new cars and one pool for new trucks..

March 1999

LTR 199925002

Accounting for Manufacturing Molds

  • Molds used in automobile parts production are unique items for purposes of IRC §460(f).
  • The manufacturer must account for the related long-term contracts using the percentage-of-completion accounting method.

May 2000

ILM 200048001

Capital Cost Reduction Payments (CCR)

  • Technical Assistance Memo outlining 5 scenarios and the appropriate treatment of each.

July 2002

LTR 200242009

LTR 200241013

LTR 200240049

Like Kind Exchanges

  • IRS ruled in all three that the transfers of vehicles followed by the acquisition of replacement vehicles, are deferred exchanges, each qualifying for non-recognition of gain or loss under section 1031


April 26, 2002

FSA 200217025

Dealer Participation

  • FSA holds that dealer participation is subject to capitalization and is not treated as a currently deductible transaction cost.


September 3, 2002


TAM 200302002


  • Subvention payments made by a manufacturer or distributor to it’s wholly-owned finance subsidiary are deductible in the year paid. Further,  the subvention payment transaction is a method of accounting requiring  the Commissioner’s consent to change.


Chapters 5, 6, & 7 | Table of Contents | Chapter 9

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