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Retail Industry ATG - Chapter 4: Examination Techniques for the Food and Beverages Industries (Grocery Stores)

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.


Chapter 3 / Table of Contents / Chapter 5
Tax Code, Regulations and Official Guidance Search


Chapter 4 - Specific Issues within the Food and Beverages Industries
(Grocery Stores)


Initial Interview Questions

Questions to ask concerning sources or adjustments to income include:

  1. Which redemption companies do you use to redeem coupons and rebates?
    • How often do you process the coupons/rebates?
    • Approximate amount of coupons redeemed?
    • How many are directly attributable to gross receipts?
    • How many are in-store coupons?
    • How many are through manufacturers/suppliers?
    • How many handling fees were charged by the coupon redemption companies?
    • Were ledgers kept on coupon redemption?
    • Who and where are the coupon checks (procedures) cashed?
    • Who endorses the checks?
  2. Who gets the manufacturers/brokers premium gifts?
  3. Is the store an authorized retailer in the Food Stamp Program?
  4. Is the store an authorized retailer in the Women, Infants and Children (WIC) Program?
  5. Does the store accept credit cards?

Income

Lack of compliance centers on the non-reporting of several types of income prevalent within the industry.  Grocery gross receipts are attributable to:

  • Coupons
  • Coupon Processing Fees
  • Rebates
  • Value of Vacation Trips; and Other Types of Gifts
  • Cash Discounts
  • Receipt of High Dollar Promotional Items
  • Pay Telephones
  • Bottle/can Redeeming
  • Money Orders
  • Video/DVD Rentals
  • Video/DVD Game Rentals
  • Credit Card Sales
  • Food Stamp Sales
  • WIC Program Sales
  • Prepaid Telephone Cards

Typically a retailer has a sales summary report that reflects the sales on a departmental basis, the amount of sales tax collected, total sales, other income received, rebates that are received and other credit transactions that originate in the stores on a daily basis.  The report also shows all of the daily debit transactions, such as voids, refunds, cash payouts, and manufacturer coupons tendered, and store coupons tendered.  The debit side will also reflect the amount of daily bank deposit.  This report is very helpful in reconciling the amount of coupons debited with the amount credited to the taxpayer's books.

Coupon Income
The taxpayer receives a fee for processing coupons.  Keep in mind that the amount credited for coupons could include the coupon handling fees.  If the amount credited for coupons exceeds the amount debited throughout the year, the taxpayer is redeeming more coupons than his customers brought in to be tendered.  This may result from the taxpayer cutting coupons to be redeemed and may reflect a potential source of unreported income. Retailers should report the income from a coupon's face value and its related handling fee at the time the coupon is received from the customer.

Rebate
Grocery stores receive many product rebates based on volume and increased purchases over prior years.  Grocers receive rebates for almost all areas, but are more prevalent in dairy products, snack items, cigarettes, film processing, meat products, candy, bread, and related items.  A technique to use to identify these transactions is the submission of a listing of suppliers to the taxpayer requesting the taxpayer to indicate the supplier(s) they received rebates from and the frequency of receipt.  From this listing the taxpayer's books and records and/or deposit slips can be checked to partially verify the taxpayer's statements. Shelving or slotting allowances are nothing new to the industry.  Grocery stores charge manufacturers substantial amounts each year for prime shelf space to display their products. Please note that vendor allowances are an issue being considered by the Retail Technical Advisor.

Promotional Items
It is a normal practice for some suppliers' sales representatives to give gifts or cash to the individuals/shareholders for buying their products instead of another supplier's products. Some of the items individuals have received include televisions, computers, telephones, microwave ovens, lawn furniture, coolers, jackets, video/DVD games and movies, value of vacation trips; food, beverages, and paper products delivered to their homes, and professional and collegiate sport team tickets.  If the grocery store is incorporated and the suppliers give promotional items directly to the shareholders, adjustments may be necessary to increase corporate receipts and to report a constructive dividend.

Courtesy Account
Many grocery storeowners maintain a customer courtesy account, a petty cash account, or a similar bank account that is completely separate from the business' regular bank account.  The purpose of this account includes but is not limited to: 1) customer courtesy transactions (i.e. postage, the sale of fishing, hunting, and similar licenses, the handling of money orders, and film development, and recording of rebates), 2) to allow employees to voucher small purchases of supplies for the store, and 3) cashing of customer payroll checks.  It is suggested the examiner inquire about the handling of a customer courtesy account and the type of transactions handled by the account.  Accounts examined contained unreported income items such as coupon redemption checks, the handling fees for coupons, income from the sale of money orders, and service fees for licenses.                             

Demonstrators
The taxpayer may have a business where individuals demonstrate products and distribute the coupons of the taxpayer's suppliers in the grocery store.  When the suppliers request demonstrations at a particular time and store, the taxpayer contacts individuals, referred to as demonstrators, from a list the taxpayer has compiled.

Some taxpayers will enter into a written contract with the demonstrator, indicating the demonstrator is being hired on a contractual basis.  The taxpayer may instruct the demonstrator on specifications by which the demonstrator would have to adhere, including not being permitted to hire assistants or replacements.  Otherwise, the demonstrator is free to employ his/her own methods in performing the demonstrations.

Demonstrators are not guaranteed a minimum amount of work, they are not required to accept jobs when the taxpayer contacts them, and the failure to accept a job does not affect their name on the demonstrator's listing.  The demonstrators are not prohibited from performing demonstration jobs offered to them by competitors.  Demonstrators typically work a maximum of sixteen hours per week and are paid a set hourly wage for each demonstration.  Demonstrators accepting jobs are sometimes asked to bring some supplies with them for which they are reimbursed.  The product being demonstrated is always provided by the taxpayer.

The taxpayers may be treating the demonstrators as independent contractors; however, they are employees.  This conclusion is supported by the distinction made in Rev. Rul. 65-188, 1965-2 C.B. 390 and Rev. Rul. 75-243, 1975-1 C.B. 322.  The degree of control exercised by taxpayers over the demonstrators in this issue and that exercised over the interviewers in the two revenue rulings is similar.  Refer to the revenue rulings for a more thorough explanation.

In some cases the demonstrators' wages were netted under promotional income, therefore, avoiding employment taxes.

Cost of Goods/Inventory

When examining a grocery store operation, consider performing the following checks on purchases and inventory:

  1. Request specific invoices to analyze (i.e., larger material amounts, unusual payees and invoices of main suppliers).  Note any errors found. Become familiar with suppliers billing invoices; what items are included in them; and where they are included (i.e., capital item purchases, trips, etc.)
  2. Request a supplier list from the taxpayer.  Analyze the list of major suppliers provided by the taxpayer, noting which supplier pays rebates and how often.  Analyze the general ledger per sales (credits) and cost of goods (credits) for rebates reported.
  3. Note any patterns of reporting the rebates (i.e., credits to sales, credits to cost of goods); considering when they are being reported (i.e., weekly, monthly, semiannually, yearly, etc.)
  4. Compare the rebate list to patterns found.  Question the taxpayer as to what type of programs or agreements they have with the suppliers that rebate (such as contracts; deal sheets; shelf space, slotting, or volume agreements, etc.)
  5. Note if IRC § 263A applies.  Verify, through probing, whether the taxpayer included rent, utilities, insurance, taxes on storage facilities, purchasing and management salaries, supplies, telephone, travel, or other IRC § 263A expenses in the amount capitalized.  Be aware of the $10,000,000 exception rule for small businesses.

    These are the usual 11 categories accounted for IRC § 263A:
  • Food and Beverages
  • Housing Maintenance and Repair Commodities
  • Fuels (other than gasoline)
  • House Furnishings and Housekeeping Supplies
  • Apparel
  • Toilet Goods and Personal Care
  • Medical Care
  • Entertainment
  • Tobacco
  • Private Transportation (including gasoline)
  • School Books and Supplies

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Page Last Reviewed or Updated: 24-Feb-2014