Retail Industry ATG - Chapter 3: Examination Techniques for Specific Industries (Gasoline Service Stations)
NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
- Initial Interview Questions
The service station has historically been the type of business where most of the income and many of the expenses are paid in cash. As such, the normal audit trail is more difficult to follow than other businesses with tighter internal controls. Sometimes no records are maintained or they are kept sporadically and in a disorganized manner. For these situations we have developed some alternative approaches to computing income for a service station under audit. In a state that has sales tax you can work through your Fed-State contacts to get gross sales information. For example, the California State Board of Equalization provides information for California service stations.
The initial interview is very important in such businesses. The following questions have been developed to assist you in evaluating a service station business:
Initial Interview Questions
These questions were developed to provide enough information for the examiner to accurately estimate the income when a Survey is not available and/or the audit is limited primarily to the income issue.
What are your gasoline products' mark-ups per grade?
Was the mark-up the same in prior years?
What is your merchandise product mark-up?
Was the mark-up the same in prior years?
Do you have inventory on consignment (fuel, merchandise, etc.)?
What is your hourly rate for mechanics?
What is the daily gasoline sales volume? By type of gasoline? By season?
What is the daily merchandise sales volume? By season?
How often do you receive a fuel or merchandise load?
Do you accept credit card sales? What percentage is gasoline? Cash?
Name all the companies you get gasoline or other products from?
What was the beginning and ending inventory for the year(s) in question?
Has the station been remodeled? When? How long was the station closed for remodeling? Who paid for the remodel? Did the taxpayer receive any reimbursement for the remodel? Did he or she receive financial reimbursements such as business income replacement?
Name all of your suppliers of gasoline and other products you offer for sale.
What percentage of gasoline sales is full service?
Do you purchase blending products such as alcohol, naphtha, and transmix?
Do you own your delivery trucks? If yes, do you supply your own fuel? Who do you buy it from?
Do you distribute your product to anyone else?
Were you required to file a Form 720 (Excise Tax) or Form 2290 (Highway Use Tax)? Did you file it (them)?
Is all fuel purchased with Federal Excise Tax included? (Obtain copies of sample invoices for all fuel types.)
Be aware of taxpayer buying tax-free. If found contact your local excise tax agent.
Number of bulk storage tanks.
Capacity of bulk storage tanks.
Number of gallons in inventory at year-end.
Is gasoline ever sold as diesel fuel?
How do customers use propane?
Are other items sold or services rendered at the location(s)?
That is, unbranded pumps, car wash, snow plows, cigarettes, beverages, vending machines, tires, repair bays, licensing for state inspections, mini-mart, lottery tickets, etc.
AAA and other towing companies - Stations often have their own trucks. They used AAA and other companies to tow in automobiles, for which the stations are subsequently paid by the towing company. Contact the auto club to determine their procedures for releasing this information.
Location and Sales ─ expect a good location site to have a high volume of sales.
Sites that have a beer and wine license will sell much more merchandise than stores without the license.
Are cars for sale at the location?
Motor Vehicle Records ─ determine local or state procedures for securing this information.
Be alert to any other service station(s) owned in whole or in part as an individual, partner, and/or shareholder.
Real Estate Records ─ for real estate sales and purchases. Contact your Collection employees for the best source of this information.
Check the current selling prices and note variances between prices of gasoline at the taxpayer's station and other stations in the area.
How many pumps? What are the grades of product being sold and are there any other types of products such as diesel fuel, propane, or blending products?
Have internal controls been addressed? Are the internal controls currently in place the same as during the year under audit?
Note: Los Angeles Counsel recommends that information about the area (good, bad, industrial, residential, etc.) be gathered for cases under their jurisdiction.
TECS - (Treasury Enforcement Communication System) money declared with Customs when taken in or out of the country selectively
State and Federal Agencies responsible for:
Weights & Measurements
Measurement Standards; etc.
Bank Deposit Analysis
A bank deposit analysis may not work for all cash businesses. Many businesses that deal heavily in cash do not deposit all cash received.
Recently, more people are using debit cards and credit cards to pay for gasoline and diesel fuel purchases. Also service bay repairs are normally paid by check or credit card. Therefore, it is now easier to use a bank deposit analysis as an indirect method to support our BLS adjustment.
The key to doing a bank deposit analysis for a service station business is to remember to add to bank deposits the amount of credit card sales and cash payouts. When a person buys gasoline at a gasoline station by using an oil company (ies) credit card, the oil company (ies) receives the credit card sales money directly. The oil company (ies) then gives the service station owner credit for his or her daily credit card sales against the fuel purchases.
Service Stations are more than dispensers of gasoline. The typical station has one or more of the following sources of revenue:
Sale of Vehicles
Repair Shops with or without Tow
A visit to the station prior to the start of the audit will make the examiner's job a lot easier. Put a copy of the map showing the location of the station in the file. Compare the prices of the taxpayer's station to competitors nearby. Do they now or did they use to offer cash discounts? One very important thing to observe is how many customers are pumping their own gasoline and how many are getting full service. Also observe the types of non-gasoline activities.
Summons the Oil Company
If initial observations suggest that the taxpayer may be underreporting income, consider issuing a summons to the oil company (ies) for records for its sales to the service station. As added by the Taxpayer Bill of Rights, IRC section 7602(c) requires that we give taxpayers reasonable notice in advance of all contacts with third parties made regarding the determination or collection of their tax liabilities. That Section also requires that we provide the taxpayer with record of all such third-party contacts. A summons served on a third party is a third-party contact under IRC section 7602(c). The advance notice of the third-party contacts required by IRC section 7602(c) must be given in addition to the notice of a third-party summons required by IRC section 7609(a). Therefore, provide the taxpayer with a Letter 3164 before issuing a third-party summons and complete a Form 12175 for each summons issued.
Give notice of this third-party summons as required by IRC section 7609(a) to the taxpayer and all other persons identified in the summons. Contact the appropriate Counsel office if you have questions about third-party summonses.
Compute purchases and sales and compare to tax return
See IRM 4.10 and SBSE Memorandum 2003-70
After opening the audit if the observations suggest that the taxpayer may be underreporting their income, do not forego the new summons requirements of TBOR II and IRC sections 7602 and 7609 along with the Acts 3415 and 3417.
Again any questions should be directed to your local Counsel office.
Go through your Internet access for your Bureau of Labor Statistics survey of periodic index of retail gasoline prices, listed by type of gasoline or diesel fuel and the service station regional location.
Print a copy of the portion of the BLS Survey that covers the area in which your area lies.
Prepared spreadsheet to tailor spreadsheets for your area using the BLS Survey information received.
Spreadsheet should include the following items:
Type of gasoline sold (unleaded, and premium)
Full or self-service
Average price of gasoline per BLS Survey
When the summoned information comes in, run the Bureau of Labor Statistics Survey (BLS) analysis for determine gasoline and diesel fuel gross receipts. Calculate the gasoline gross receipts by multiplying the BLS price and the gasoline gallons purchased (per the summons) to compute the potential gross gasoline sales. Then compare this calculated amount to the amount on the tax return and determine whether an adjustment is indicated. Do not forget to consider non-gasoline sales when comparing your BLS computed gasoline and diesel fuel sales to the tax return.
Compare the dollars and gallons-purchased information received from the Oil Company (ies) to the tax return. Remember, this is only the gasoline/diesel fuel sales and there are probably other items being sold at the station. See below for other items.
A realistic approach to using any other survey is to consider its reliability as a gross sales analysis tool and its defensibility in court. Any reference to surveys should include the new statutory provision and examination restrictions. In the case of an individual taxpayer, IRC section 7491(b) places the burden of proof on the Service with respect to any item of income which was reconstructed solely through the use of statistical information (for example, BLS statistics is "solely" used to reconstruct Income). Further such "sole" use of statistics is contrary to Service guidance which limits it usage to non-filing and uncooperative taxpayers.
While we believe that a proper examination as described in this ATG would not run afoul of IRC section 7491(b) and that these surveys can continue to be used to determine income. We emphasize again that they may only be used in conjunction with other information, which would support a conclusion of unreported income.
Surveys can be used but we must first show that either the books and records are unavailable or that they are inadequate to determine the substantially correct tax.
Bureau of Labor Statistics (BLS)
This is a Government Indexes and Databases survey covering approximately 82 markets throughout the United States. It does not compile data by Oil Company (ies) but instead compiles data by type of gasoline/diesel fuel. This survey has been successfully used in court. Stafford v. Commissioner T.C. Memo 1992-637.
While BLS statistics can be used to support an income adjustment, such statistics may not be used solely to determine income. IRC section 7491(b).
American Automobile Association (AAA)
AAA canvases the United States. There has not been a court case using this survey. Area Counsel should review AAA survey before it can be used. Provides in its AAA Daily Fuel Gauge Report, comprehensive retail gasoline surveys, based on daily data taking in over 60,000 self-serve stations.
U.S. Department of Energy
Currently each state is required, under the old Windfall Profit Act, to survey its area for prices. Some states use outside surveys such as AAA. Others do their own survey. Although limited to the area surveyed, this may be a useful method to discover your taxpayer's area pricing.
The Lundberg Survey provides retail-selling prices for gasoline and diesel fuel. The prices are listed by: type of Oil Company, full service, self-service, credit, cash, and grade of gasoline. The use of this data source was upheld in Barragan v. Commissioner, TC Memo 1993-92, aff’d 76 A.F.T.R.2d 95-5629, 95-2 U.S.T.C. 50,624 (9th Cir, 1995).
U.S. Department of Commerce
Economics and Statistics Administration, Bureau of the Census, provides a periodical Census of the Retail Trade, including Gasoline Retail Stations.
Suppliers can be located through your local telephone directory. Cigarette distributors also can be located through the local food wholesalers. These suppliers usually supply invoices with not only purchases but with suggested sale prices.
Look for the total sales of these products. Then find out where purchases were made and how they were made (cash, credit, etc.).
Auto Body Repairs
A unique method recently found is the use of the state smog certificate/inspection information available through the state. In California this would be the California Bureau of Automotive Repairs. This information not only gives us the actual smog certificates issued BUT also the repairs made to bring the car to certification level.
Notice that when comparing the records presented to the examiner during the audit and the records presented from the state the information should match. If not, there is underreporting.
Sale of Business Assets or Franchise
Sales of service stations go through escrow and are recorded in document repositories such as the county court houses (for example, in Los Angeles at the Hall of Records).
Frequently, the taxpayer(s) has sold either the gasoline station or other properties and the capital gain has not been reported. Watch out for this. Real estate records are helpful with real property.
The oil company (ies) has agreements that allow new owners to purchase the assets of the business and pay off the liability by being charged an extra few cents a gallon for purchases.
Since this should not be charged to cost of goods sold, but rather should be charged against a payable, agents should obtain copies of the purchase agreement and discuss this at the opening conference. The extra charge is a combination of interest and principal and must be distinguished.
Agents should consider the impact of the sale of franchise rights and franchise agreements/lease versus sales.
There have been cases where taxpayers file a tax return, including a Schedule C, but omit one or more of their other gasoline stations. When serving the summons, request "this station and any other stations, owned or operated by (the taxpayer)." Watch for statements showing deliveries to different addresses and other clues that the taxpayer owned more than one station.
Provide both the Social Security Number and Employer Identification Number on the summons to assist the oil companies in this search.
Note: A significant variance between monthly purchase volumes could indicate the sale or purchase of a station or multiple suppliers.
Bay services income sources consist of an hourly rate and parts charges. Although each Area has a different hourly rate, the rate is usually posted at the business and the consumer is notified of it before the repair is authorized. Anyone going to their local mechanic will see the amount. The charges for parts also vary depending on Area.
In order to illustrate a very simple example of this source of income, we will work with only one bay and one mechanic. In this example, the hourly rate charged is $40 for 6 hours work for a total of $240 in income.
Daily income $240
Per person wage of $20 for 8 hours 160
Profit per day $ 80
At $80 per day and 315 days worked, the total amount of gross profit is: $25,200
Note: This does not include parts, where there is normally a 50 percent or better mark-up. This $25,200 could double if the average part sold was, for example, $240, and the cost was $160. The service bay profit would be $50,400. Also, note this is for one bay; usually there is more than one bay per station.
Service Parts Suppliers
The typical service repair station purchases parts on a cash basis. Following this trail is very difficult but not impossible. First, review the overall income per service bay. The mechanic bay example above would have over $750,000 per service bay in just the hourly rate. The mechanic is usually an employee.
Review the repair invoices, which should be sequentially numbered and reasonable in amount. For example, there should be a labor charge, not just a charge for parts. Also consider what to do about missing invoices. Look for the voided, and estimates of, service bay repair invoices. The examiners should be able to interpolate from these available invoices the total service bay repair income.
Remember, if a station owner shows you a repair bay operating at grossly less than the wages of its mechanic, there is further reason to investigate.
Another situation, which appears in a number of cases, is the double deducting of the expenses. For example, many oil companies bill the taxpayer through the purchase invoices, for items such as rent. The taxpayer takes the full amount of the purchase invoice as a purchase deduction and also takes the rent (again) as an "other expense" of the total ordinary business expenses. Check for this on rent statements or purchases statements. The agreement between the dealership and Oil Company (ies) is also a good source of information.
Another problem with rent occurs when the taxpayer takes the full amount shown for rent per the purchase invoices. However, most of the major oil companies charge rent based on gallons purchased, but then the oil company (ies) gives the taxpayer a rent rebate.
Franchise Fees and Covenants Not to Compete
This could be disguised goodwill. Goodwill is an intangible asset as defined in IRC section 197. For pre-August 11, 1993, acquisitions, goodwill (for example; acquired in connection with a franchise) cannot be written off, but remains on the books as a capitalized item. For purchases of a franchise entered into after August 10, 1993, the taxpayer must amortize the intangible asset (even if part of the intangible is disguised goodwill) over 15 years using the straight-line depreciation method. IRC section 197 was added in the Revenue Reconciliation Act of 1993 and permits 15 years straight-line depreciation for IRC section 197 intangibles, which specifically include franchise fees, covenants not to compete and goodwill. A taxpayer may elect to apply the provisions of IRC section 197 retroactively to property acquired after July 25, 1991. Don’t forget to consider the whipsaw issue between what the taxpayer claims as an expense and what the seller claims as a capital gain.
Sometimes the taxpayer has a 1- or 2-cent additional per-gallon charge on the invoice. This money is placed in somewhat of a savings account. It is the taxpayer's money and he or she earns interest on the deposits (check Form 1040, Schedule B). Check to ensure that the taxpayer has not claimed this as a cost of goods expense. The reserve account is included on the gasoline purchase invoices. Make sure that if you see gasoline reserve on a purchase invoice that the bottom amount of the purchase invoice does not include the prepayment amount. Additionally, ensure that the taxpayer has included as income any interest credited to this account for benefit of the taxpayers.
Major oil companies give rebates for increased purchases. These are incentive programs. Generally, rebates are required to be offset against the purchase price of the merchandise on which rebates are computed. The most common one used is for a new owner of a station or an owner who has remodeled his or her station. This is frequently 2 to 5 cents per gallon, applied to the volume increase and can total up to $100,000 per station, per year. The oil company (ies) will generally apply this to the station rent or as a credit to the taxpayer’s account.
Check to insure that the taxpayer does not deduct the full amount of the purchase through cost of goods sold without reducing it by the rebates. See Treas. Reg. section 1.471-3(b). Lately, the major oil companies will pay a rebate for the stations to be shut down for remodeling or replacement of the under ground storage tanks. Some oil companies give rebate incentives for stations being open 24 hours.
A change to correct the timing of when a taxpayer accounts for purchase rebates (for example, income versus reduction of the price of purchased merchandise) is a change to the taxpayer's method of accounting to which the provisions of IRC sections 446 and 481 apply. See Rev. Proc. 97-27, 1997-1 C.B. 680.
Watch out for amounts equal to taxes (sales and excise) collected by the oil companies but not shown in the purchase documents summoned. It is important to determine whether these amounts were included in the total dollars and per-gallon figures of the summoned documents. (Very important: The retail-selling price in the BLS Survey includes all appropriate taxes. Make sure that any prepaid taxes are included in the purchases.) It is a common practice for the gasoline station (and their suppliers) to collect the amount of sales tax or excise taxes from the consumer. Watch out for double deductions, that is, taxes to be included in the cost of goods sold as well as a separate expense item.
The federal taxes on gasoline, diesel fuel, and, beginning July 1, 1998, kerosene, are imposed on the products before the products are delivered to the service station. Thus, the Retailers are not responsible for paying these taxes to the government; rather, the amount of the taxes is usually included in the station's purchase price of the products. This is common in many states. However, see the discussion of "Blending," below. The operator generally is liable for the tax on propane and other liquefied petroleum gasoline (LPG) that it sells for use in vehicles.
The oil companies collect the pre-collected sales tax. The taxpayer receives credit for this pre-collected sales tax on their state sales tax returns. One common problem found during audits is where the taxpayer deducts the full amount of the gasoline and diesel fuel purchase invoiced as purchases per return. However, many taxpayers report their gross receipts net of sales taxes. Therefore, if a taxpayer reports their gross receipts net of sales taxes, then make sure their purchases are reported net of the pre-collected sales tax.
Diesel fuels and kerosene that has been dyed red according to Treasury Regulations has not been taxed when the fuel is delivered to the service station. A legible and conspicuous Notice stating either: DYED DIESEL FUEL, NONTAXABLE USE ONLY, PENALTY FOR TAXABLE USE, or DYED KEROSENE, NONTAXABLE USE ONLY, PENALTY FOR TAXABLE USE must be posted by the seller on any retail pump where it sells dyed diesel fuel or dyed kerosene for use by its buyer. A substantial penalty (and tax) may be imposed on a person that sells dyed fuel for a taxable purpose, such as for use in a registered highway vehicle. If you suspect that these rules are being violated, contact your excise tax group immediately.
Some service stations sell gasoline and diesel fuel into which the operator has added previously untaxed liquid. Stations may blend to generate more sales per gallon of gasoline or diesel fuel purchased. The most common products used for blending include naphtha, alcohol, transmix, waste oil, and (before July 1, 1998) kerosene. Generally, the blender owes excise tax on this increased volume of fuel. If you suspect that a blender is not paying the tax to the government, contact your excise tax group immediately. If you find an invoice for one of these blending products, serve a summons for all purchases and add this to the original gasoline or diesel fuel purchases before applying the BLS pricing. Note that the taxes (both excise and sales) could be over 40 cents per gallon.
Examples of "Blending-Product Switching" Recipes for Higher Profits
In this example, 2,000 gallons of regular unleaded gasoline are sold as premium unleaded gasoline.
Product Purchases Product Sales
Product .……………....Gallons Product …..…….............Gallons
Reg. Unlead 5,000 Reg. Unleaded 3,000
Prem. Unleaded 1,000 Prem. Unleaded 3,000
Gals. Taxed & Purchases ----- Gals. Taxed &Purchases -------
In this example, 5,000 gallons of regular unleaded gasoline become 5,000 gallons of premium.
Product Purchases Product Sales
Product ………..……....Gallons Product ………..................Gallons
Reg. Unleaded 5,000 Reg. Unleaded -0-
Prem. Unleaded -0- Prem. Unleaded 5,000
Gals. Taxed & Purchases ----- Gals Taxed & Purchases -----
In this example, 6,000 gallons of regular unleaded were mixed with 1,000 gallons of previously untaxed naphtha and premium unleaded. It is sold as premium unleaded. The amount of the tax from the sale is collected but not reported.
Product Purchases ___ Product Sales
Product ……….........Gallons Product ……..……............Gallons
Reg. Unleaded 6,000 Reg. Unleaded * 4,000
Prem. Unleaded 1,000 Prem. Unleaded * 4,000
Naphtha 1,000 -------
--------- Gals. Taxed on Sale 8,000
Gals. Purchased 8,000
*Gals. Tax Paid On 7,000
In this example, 6,000 gallons of diesel fuel is mixed with 1,500 gallons of previously untaxed transmix and sold as diesel fuel. The amount of the tax from the sale is collected but not reported.
Product Purchases Product Sales
Product ……….........Gallons Product ……..……............Gallons
Diesel fuel 6,000 Diesel fuel * 7,500
Transmix 1,500 -------
------- Gals. Taxed on Sale 7,500
Gals. Purchased 7,500
*Gals. Taxes Paid On 6,000
Oil Company (ies) sometimes makes cash or property payments to a gasoline station owner for the purpose of improving the image of the owner's station - thus the name “imaging reimbursement payments”. The station owner maintains title to the improvements. Improvement of the station may be contingent upon the station owner purchasing a specified volume of petroleum products.
Monies are given to the station owner to be used for signs, painting, and overall appearance improvement. This money is also issued to either change brands (re-branding) and/or to improve the general conditions of the station.
Issues arise because:
The cash is usually called a no-interest loan and there is no expectation of repayment.
Sometimes the contract reads that there is expectation of repayment but provisions are so vague that anyone can meet them and no repayment is made.
Payments usually exceed costs involved and the taxpayer may capitalize the improvements even though he is not the true owner of the property.
Or, the taxpayer may deduct the expenses and not report the income.
Types of Reimbursements
The oil company (ies) may disburse the cash payments in a lump sum or in a series of payments upon the purchase of petroleum products. The oil company (ies) might also require the station owner to pay for the improvements before disbursing the cash payments.
How Should It Be Reported?
The facts and circumstances of your specific image upgrade program may vary from the typical program and produce different tax results. For example, the tax results may vary depending on the relationship of the cash payments to the purchases of petroleum products, the nature and ownership of the image upgrades, or the contractual relationship between the gasoline station owner and the oil company (ies). We recommend that a gasoline station owner consult with a tax advisor to determine the proper tax treatment.
Typical Treatment by Recipient
- Cash Payments
Generally, a gasoline station owner should include the cash payment fully in gross income in the taxable year that is proper under the station owner's method of accounting.
In an overwhelming majority of cases, station owners must use an accrual method of accounting. If the purchase, production or sale of merchandise is an income-producing factor in the taxpayer's business, then the taxpayer generally must maintain inventories. But see Rev. Proc. 2001-10, 2001-2 I.R.B. 272, 2001-1 C.B. 272 (Jan. 8, 2001). (Providing a “small taxpayer exception” from the requirements to use an accrual method under IRC section 446 and to account for inventories under IRC section 471 for taxpayers with average annual gross receipts of $1,000,000 or less.)
Taxpayers who maintain inventories are required to use an accrual method of accounting unless the Commissioner authorizes the taxpayer to continue to use its present method of accounting. The courts have developed a test to determine whether the Commissioner has abused his discretion in not permitting a taxpayer to continue to use its present method. That test is the substantial identity of results test (SIRT). If a taxpayer meets the SIRT then it will be permitted to continue to use its present method.
Under the SIRT, the taxpayer must establish that its present (generally cash) method of accounting produces substantially identical results to the accrual method proposed by the Service. The courts have held that where the difference is as little as 1.32 percent or 1.6 percent the methods do not produce substantially identical results. Wilkinson-Beane v. Commissioner, 420 F.2d 352 (1st Cir, 1970); Surtronics, Inc. v. Commissioner, T.C. Memo 1985-277.
A gasoline station owner may deduct certain costs paid with monies received under an Image Upgrade Program. To be deductible, these costs must be for ordinary and necessary expenses paid or incurred in the taxable year for carrying on a trade or business. Deductible cost may include incidental repairs and advertising.
A gasoline station owner is not permitted to deduct any costs paid or incurred for new buildings or permanent improvements or betterments that increase the value or prolong the useful life of property. These costs must be treated as capital expenditures. For example, expenditures for new signage and new gasoline pump. Generally, such costs may be recovered through depreciation or amortization. Any remaining basis is taken into account in determining gain or loss when the property is sold or otherwise disposed of.
In the first year in which a taxpayer begins to capitalize costs required to be capitalized, which the taxpayer has consistently deducted in the past, there is a change in the taxpayer's method of accounting to which the provisions of IRC sections 446 and 481 apply.
- Other compliance issues:
- The money received may not be used for business purposes.
- The taxpayer may treat the payment as a loan, and then capitalize the improvements.
- The taxpayer deducts the expenses and does not report the income, or
- Attempts to defer the inclusion of income over time.
Questions to Answer
Several questions arise in deciding whether or not an amount received should be considered a loan or income to the recipient:
- Was there a debtor-creditor relationship created at the time the proceeds in question were received by a party to the transaction?
- Was there intent to repay the other party?
- Did the creditor intend to enforce the "obligation"?
- Was the transfer documented and evidenced by written agreements? (For example, is there a note?)
- Was interest paid?
- Was there regular repayment of principal or interest by the debtor?
- Was there a specific date for repayment of a sum certain by the debtor? Alternatively, was the repayment predictable and realistic?
Most loans usually have a date certain for repayment and a defined periodic payment amount (for example, bank home loans). In some situations there may not be a definite periodic payment amount being repaid, such as payment per gallons purchased. It is not necessary to have a definite fixed monthly amount to have a valid loan as long as the taxpayer’s loan meets the court's definition of a bona fide loan (as discussed below).
What is a Loan?
The Tax Court considered certain objective facts to determine the taxpayer's intent and whether a bona fide loan occurred. The factors derived from case law and applied by the Tax Court included:
- The existence or non-existence of a debt instrument;
- Provisions for security; interest payments and fixed payment date;
- Whether or not repayments of a loan were made;
- The taxpayer's ability to repay the loan; the borrower's receipt of compensation; and the testimony of the taxpayer the repayment of loan must be unconditional and not contingent upon some future event. Frierdich v. Commissioner, T. C. Memo, 1989-103 aff’d, 925 F.2d 180 (7th Cir 1991). See also Colombo v. Commissioner, T.C. Memo 1975-162.
These agreements go by many names. Some of these have been noted above, such as imaging or rebates. Incentive "awards" or agreements may be paid in many fashions, usually as a discount of certain cents per gallon or a discount for purchases over a certain monthly volume. This money may also be given to the taxpayer as a lump sum. Some large oil companies pay this on total yearly sales. Notice that this could be quite a sum of money if the taxpayer sells millions of gallons of product. Competitive allowance, paybacks, advertising allowance or subsidies, and profit participation are just a few names given to these agreements.
Payments between the major oil companies and service station dealers may involve the refund to dealers of gasoline purchase charges in excess of the customary charge for gasoline. The excess charge is retained in a separate account to be used for the discretionary benefit of the dealer. This could be called a number of things, such as liquidation/accommodation agreement, or security agreement.
Disbursement of the funds could go directly to the dealer or payments are made on behalf of the dealer to a third party.
This type of agreement allows the dealer to take the full amount of the invoice when only the actual business expense should be deducted. Disallow the accommodation amount included in the purchases. This will decrease cost of goods sold and increase gross profit.
Shrinkage, Leakage, Theft, and Personal Use
Although the taxpayer may claim these as reasons for substantial loss of gallonage or a discrepancy in the cost of goods sold, experience has shown that this amount should be de minimus. Any large amount claimed should be substantiated. For example if there has been substantial leakage, the local environmental agencies or fire department would have been involved in the cleanup.
This is a depreciation expense to the OWNER of the property. Generally, the major oil company (ies) owns the property. Lately, the major oil companies will pay a rebate for the stations to be shut down for remodeling or replacement of the underground storage tanks. Revenue rulings that reflect particular allowances for depreciation for owners:
Depreciation, Revenue Ruling 98-25, 1998-19 I.R.B. 4, 1998-1 C.B. 998
Environmental Cleanup, Revenue Ruling 94-38, 1994-25 I.R.B. 4, 1994-1 C.B. 35
Environmental Cleanup, Revenue Ruling 2000-78, 2000-9 I.R.B. 712, 2000-1 C.B. 712
Moreover, IRC section 168(e) (3) (E) specifically includes as 15-year property “any IRC section 1250 property which is a retail motor fuels outlet (whether or not food or other convenience items are sold at the outlet).”
For purposes of applying these class demarcations to service station building and canopies, IRC section 1245 property is personal property, while immovable property or land improvement have to be considered IRC section 1250 property.
Thus, the qualification for the shorter 5-year life depends on whether the particular asset can qualify as personal property. If so, the asset may be depreciated over 5-years (in Class 57.0 the asset has a class life of 9 years which, under IRC section 168(e), renders it 5-year property). Note that this could apply not only to canopies but also to modular service station buildings. Conversely, if the asset cannot be considered personal property but must be considered a building, a structural component of a building, or land improvement, in other words something which would be considered immovable property, the asset falls into Class 57.1 with a Class life of 20 years, rendering it 15 year property under IRC section 168(e).
Gasoline Retail Station Building vs. Other Nonresidential Building (5 years, 15 years, 39 years)
If the Service Station building is a modular structure and would have to be considered movable personal property, it would fall into Class 57.0 with a 5-year depreciation period. Typically, only smaller modular structures (for example, kiosks) will qualify. In Rev. Rul. 75-18, 1975-1 C.B. 9, abandoned the functional use test. Thus, the mere fact that a modular structure is used like a building does not require its characterization as a building. The critical indicia are, as later highlighted in Whiteco Indus., Inc. v. Commissioner, 65 T.C. 664 (1975), whether the permanence of the structure is evident from the installation and the design. Fox Photo Inc. v. CIR, TC Memo 1990-348, emphasized again the criteria of whether the structure is easily movable and whether constructed in a manner that reflects anticipation of the structure having to be moved. The absence of a plan to move a modular structure is not critical, that is, indefinite installation does not taint the personal property characterization.
Fixed Station Buildings
If there are significant sales other than traditional gasoline station products (motor fuel, lubricants, tires, batteries, other auto accessories, soft drinks and cigarettes), that is, in the case of a convenience store that is combined with gasoline sales, test the facility to determine whether it is used primarily in petroleum marketing. For Service Station Buildings (other than modular buildings, which would qualify as personal property), the Coordinated Issue Paper of April 2, 1997, provides further guidance. It discusses IRC section 168(e) (3) (E) as added by section 1120 of the Small Business Job Protection Act of 1996 (the Act). This section now provides that the term "15-year property" includes
“any section 1250 property which is a retail motor fuels outlet (whether or not food or other convenience items are sold at the outlet).”
The legislative history (S.Rep. No. 281, 104th Cong., 2nd Sess. 15 (1996)) envisions for a gasoline retail outlet that at least 50 percent or more of the
Gross revenues are generated by traditional gasoline station retail, or
Floor space in the building (including restrooms, counters, and other areas allocable to traditional service station "services") are devoted to the petroleum marketing activity.
"Gross revenue" is defined as the revenue generated by the sale of the product to the consumer. For purposes of determining whether a C-store building qualifies as a retail motor fuels outlet, gross revenue includes all excise and sales taxes.
The gross revenue attributable to petroleum sales (motor fuel, lube oil, battery, tires, auto accessories and other traditional motor fuel retail outlet sales) should be compared to gross revenue from all other sources (for example, food items, beverages, lottery, video rentals, etc.). If the petroleum sales as reflected in (a) receipts or (b) floor space utilization, are greater than the non-petroleum sales receipts or floor use, the building qualifies as 15-year property. The gross revenue should be analyzed for a full tax period.
Temporary fluctuations in the results of the revenue analysis should not be used to determine whether the building qualifies or fails the gross revenue test. For example, if a special promotion is run for a 6-month period and the gross revenue ratio is temporarily affected, the primary use of the building should not be changed. If the building initially meets (or fails to meet) the disjunctive 50-percent test, but subsequently fails to meet (or meets) such test for more than a temporary period, such failure or qualification is a change in the use of the property.
If either the petroleum sales or floor space use tests is satisfied, the building is treated as 15-year property; otherwise, the building should be treated as an ordinary retail building and, as a nonresidential real property has a 39 year life (31.5 years for buildings placed in service May 13, 1993). However, small structures of 1400 square feet used in the context of gasoline retailing need not to be tested and should be accepted as qualifying under IRC section 168(e)(3)(E) as gasoline retail outlets. See Sec. 2, Rev. Proc. 97-10, 1997-1 C.B. 628.
Change in classification is change in accounting method – gasoline stations
IRC section 168(e) (3) (E) is effective for structures placed in service after August 19, 1996. Taxpayers may elect to apply the provision to property that was placed in service before August 20, 1996. According to the legislative history, if a taxpayer has already treated the property as 15-year property the taxpayer is deemed to have made the election. If a taxpayer has not treated the property as 15-year property the Service treats the election as an accounting method change, with automatic consent granted as provided in Rev. Proc. 97-10, 1997-1 CB 628, supra.
Car-wash buildings, associated land improvements
Car Wash Buildings are enumerated in Asset Class 57.1 property with 15-year depreciation, as are associated land improvements, such as pump islands.
Canopies, Gasoline Brand Signs
Canopies are in Class 57.1 with a 15-year life, unless they qualify under the Whiteco test; see above as personal property for Asset Class 57.0 and 5-year depreciation. In JFM, Inc. v. CIR, T.C. Memo 1994-239, the court held canopies to be personal property in Class 57.0, with a 5-year life. The canopies in that case were bolted down onto four to six special concrete footings. Of the 14 canopies at issue, the taxpayer had sold 2 to third parties for reuse, and at least 3 had been taken down and either moved to another location or had been rebuilt and reinstalled at the same location. Thus, some of these canopies had in fact been moved.
The tanks, pipelines, and pumps
Underground storage tanks, fuel dispensing pumps, and other automobile service equipment are under the Whiteco test typically considered personal property and to be subsumed to Class 57.0 with a 5-year life.
Environmental clean-up issue
Rev. Rul. 94-38, 1994-1 C.B. 35, generally provides that costs incurred to clean up land and treat groundwater that a taxpayer contaminated with hazardous waste from its own business are deductible by a taxpayer as ordinary and necessary business expenses under IRC section 162. However, such costs do not include costs attributable to construction of buildings, machinery and equipment having a useful life substantially beyond the taxable year (as determined under IRC section 263 and the regulations thereunder). These costs are nondeductible capital expenditures under IRC section 263.
Rev. Rul. 94-38 does not apply in situations where a taxpayer cleans up land that was contaminated prior to its acquisition. In those situations, general principles of capitalization under IRC section 263 are controlling.
A change to require the taxpayer to begin capitalizing costs required to be capitalized, which the taxpayer has currently deducted, is a change to the taxpayer's method of accounting to which the provisions of IRC sections 446 and 481 apply.
Moreover, neither IRC section 162 nor section 263 applies when the costs incurred are reimbursable. Therefore, where there is a reasonable expectation of reimbursement, costs incurred for environmental cleanup may not be capitalized or deducted.
There are numerous state websites. Please consult the following national websites for their individual state association sites:
A G O (Atmospheric Gasoline Oil) a volatile distillate.
Back-Up Tax 24.4 cents per gallon tax is imposed on dyed diesel fuel that is sold or used for other than a nontaxable purpose. (In addition to penalty)
Cetane Number a measure of the ability of a fuel to ignite spontaneously, desirable in the operation of a diesel fuel engine.
Cloud Point and Count Point describe the flow characteristics of fuel oil at low temperatures. These points are the temperatures at which wax crystals form and clog the fuel-injection system of a diesel fuel engine.
Distillate a refined petroleum product produced by the distillation of crude oil.
Dyed Diesel Fuel regulations specify dye concentration. Notice of dyeing is required on paperwork by terminal operators, distributors, and on retail pumps where dyed diesel fuel is sold. A penalty of the greater of $1000 or $10 per gallon is imposed for selling or using dyed diesel fuel for a taxable use or for altering dyed diesel fuel.
Excise Tax Agent audits excise tax returns (Forms 720 and 2290) and imposes back-up tax. All potential excise tax issues should be referred to the Excise Tax Group.
Form 637 diesel fuel producers, refiners, importers, terminal operators, blenders, through putters, compounders and others, such as those selling or buying taxable items tax-free, are registered on Form 637.
Form 720 used to report and pay the excise taxes listed on the form. A return should be filed for each quarter.
Form 2290 used to compute and pay the tax due on heavy vehicles used on public highways. It is also used to claim exemption from the tax when such vehicles are expected to be used on public highways 5,000 miles or less (7500 miles or less for agricultural vehicles). Proof of payment of this tax is required to register your vehicle in any state.
#1 Diesel Fuel a volatile distillate fuel used in high speed diesel fuel engines operated under wide variations of speed and load, such as city buses.
#1 Fuel Oil a light distillate used in vaporizing-type burners.
#2 Diesel Fuel a lower volatility oil for use in high-speed diesel fuel engines operated generally under uniform speed and load conditions, such as railroad engines and highway roads.
#2 Fuel Oil a distillate used in atomizing type burners for home and other moderate size heating applications.
#4 Diesel Fuel used in low speed diesel fuel engines.
#4 Fuel Oil a blend of distillate and residual fuel oil used for commercial burners in larger size heating applications, such as industrial plants.
Kerosene similar to #1 fuel oil with specifications that improve it for use in space heaters, cook stoves and lamps.
M D O (Marine Diesel fuel Oil) a volatile distillate used specifically for marine/ship purposes.
Naptha/Alcohol used to mix with diesel fuel and gasoline. Naphtha has no real purpose outside of blending with other products. While, alcohol can be legally blended up to 10% and sold as gasoline.
Non-TaxableUses 1) Use on a farm for farming purposes; 2) Exclusive use of state or local government; 3) Use other than as fuel in the propulsion engine of a highway vehicle, boat, or train; and 4) other limited uses.
Rack a mechanism for delivering fuel from a refinery or terminal into a truck, trailer, railroad car, or other means of non-bulk transfer.
Residual Fuel Oil a heavy oil that remains after distillation which is used for electric power generation, space heating, ship bunkering and various industrial application. Includes #5 and #6 fuel oils.
Taxable Event removal from terminal rack, entry into the United States, or removal or sale of blended diesel fuel.
Transmix the portion of products mixed in transport, that is, diesel fuel is mixed with gasoline while in transit.
Ultimate Vendor seller of undyed diesel fuel to the user of the fuel (purchaser) for use on a farm for farming purposes or for the exclusive use of state or local government. Registration (Form 637) is required in order to qualify for refund or credit.