Do you provide finance and/or insurance for your customers?
What is it?
Related Finance Companies refer to the self-financing arrangement pursued by some dealerships, new and used, where individuals for whom financing cannot be obtained through normal channels. The customer is required to make payments usually at the dealership's location.
How does it work?
Dealerships involved in this practice establish a financing entity, typically an S-Corporation, which acts as the financial institution in the dealership's selling arrangement.
When the vehicle is sold, and it is determined that the customer needs special credit assistance, the dealership writes the note at term (high interest rate) with recourse as the lender. Then the note is sold at significant discount to the entity substantiating the discount by citing high risk. For more information, refer to the Independent Used Car Dealer Guide.
If you own two entities (regardless of the type of entity) and you own more than 50% of each entity, any loss from the exchange of property between these entities may not be deductible. For more information refer to IRC section 267.
Extended Service Contracts
Motor vehicle dealers sell two basic types of extended service contracts (also known as mechanical breakdown contracts or multi-year service warranty contracts) for used cars and as a supplement to the standard manufacturers' warranty for new cars. The first type is between the customer and an unrelated underwriter. The dealer is merely an agent for the underwriter and keeps as profit the difference between the sales price of the contract and the "cost" paid to the underwriter.
The second type is a contract between the customer and the dealer. For this type the dealer may buy insurance covering his or her risk or be "self-insured". If the dealer buys insurance, the income and expenses should be reported in the year of receipt, and any prepaid insurance must be amortized over the life of the policy.
The taxpayer can elect to mitigate this situation by filing Form 3115 (PDF) to request changes in accounting methods. Revenue Procedures 97-38 (PDF) and 99-49 (PDF) explain the filing procedures, which allow taxpayers to report income ratably as they expense the insurance ratably.
Installment Method - Automotive Tax Tips
What is an Installment sale?
Trends and Statistics – Automotive
This section provides industry-specific trends and statistics, as well as general resources for small business owners.Office of Automotive Affairs
The mission of the Office of Automotive Affairs is to facilitate and expand global business opportunities for U.S. automotive vehicle and parts manufacturers. OAA achieves its objectives through a variety of programs, ranging from market access and other trade policy initiatives, market analysis, and business counseling, to selective export promotion initiatives. This site provides links to trade statistical data.
International Trade Data System - Auto Industry
The International Trade Data System (ITDS) is a federal government Information technology initiative (Initiative IT06) of the National Performance Review. The goal of the initiative is to implement an integrated Government-wide system for the electronic collection, use, and dissemination of international trade data.
Bureau of Labor Statistics
The Bureau of Labor Statistics is the principal fact-finding agency for the Federal Government in the broad field of labor economics and statistics
New Vehicle Dealership Audit Technique Guide
Overview of the issues that exist in the motor vehicle dealer industry – including some of the basics about books and records and specific issues that exist, including extended service contracts, service technician tool reimbursements and other compensation issues.
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. The installment sales rules do not apply to the regular sale of inventory.
If you finance the purchase of your property, instead of having the buyer get a loan or mortgage from a third party, you probably have an installment sale. It is not an installment sale if the buyer borrows the money from a third party and then pays you the total selling price.
If a sale qualifies as an installment sale, the gain must be reported under the installment method unless:
If you use an accrual method of accounting, you cannot use the installment method to report gain on any property sold or disposed of after December 16, 1999. However, this rule does not apply to the following sales.
The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land, contract, mortgage, or other evidence of buyer's debt to you.
Sales of personal property by a person who regularly sells or otherwise disposes of the same type of property on the installment plan cannot be reported under the installment method. This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. However, the rule does not apply to an installment sale of property used or produced in farming.
Special Rule - Dealers of timeshares and residential lots can report certain sales on the installment method if they elect to pay a special interest charge. For more information refer to IRC section 453(I).
Each payment on an installment sale usually consists of the following three parts.
In each year you receive a payment, you must include the interest part in income, as well as the part that is your gain on the sale. You do not include in income the part that is the return of your basis in the property. For additional information, see Publication 537, Installment Sales.
Installment Sale Basis
The three items that comprise of installment sale basis are:
The Form 6252 will help you determine the following:
Use Form 6252 to report an installment sale in the year it takes place and to report payments received in later years. Attach it to your tax return for each year.
If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you do not receive all the sale proceeds in that year.
To figure the gain to report, use the fair market value (FMV) of the buyer's installment obligation. Notes, mortgages, and land contract are examples of obligations that are included at FMV.
You must figure the FMV of the buyer's Installment obligation, whether or not you would actually be able to sell it. If you use the cash method of accounting, the FMV of the obligation will never be considered to be less that the FMV of the property sold (minus any other consideration received).
When to Elect Out
You must make the election by the due date, including extensions, for filing your tax return for the year the sale takes place.
Retail Industry ATG - Chapter 3: Examination Techniques for Specific Industries (Independent Used Automobile Dealerships)
The Audit Techniques Guides (ATGs) focus on developing highly trained examiners for a particular market segment. These Guides contain examination techniques, common and unique industry issues, business practices, industry terminology and other information to assist examiners in performing examinations.
The used car industry is composed of two major segments. The first segment is made up of the new car dealers who accept trade-ins on the sale of new automobiles and can also purchase used vehicles directly from customers, other car dealers, or at wholesale auto auctions. The new car dealers then sell the used vehicles either to retail customers, to used car dealers, directly to wholesalers through auctions, or to other miscellaneous customers.
The second segment of the industry is made up of independent auto dealers. These dealers are not affiliated with an automaker and, their principal business is the sale of used vehicles. Since no trade franchise (that is, General Motors, Ford, etc.) is necessary, the size of the used car dealership and the capital required to enter the industry varies. However, every used car dealer must be licensed with the state in which the dealership is physically located.
Most states have different laws that govern the ability of individuals or businesses to sell used vehicles without a license. For example, one state permits an individual to sell up to five vehicles per year without obtaining a license. Other states are more or less restrictive. Independent auto dealers acquire vehicles from trade-ins on the sale of used vehicles. Such dealers also purchase vehicles from individuals (private purchase arrangements), other new and used vehicle dealers, and at wholesale or retail auctions.
Every state regulates the operations of the independent dealer and requirements vary from state to state. The specific requirements imposed on a dealer depend on the particular state in which the dealer does business.
Common dealership activities regulated by states include:
Transfers, assignments, and reassignments of titles
Title transfer processes
Collection and repossession rights and liabilities
Consignment rules and procedures
Payments of commissions for referring buyers
Additional information on state laws may be obtained from your state Motor Vehicle Division.
One problem that the industry faces is competition from unlicensed dealers (curbstoners) who buy, sell, and trade more used vehicles than a state allows without a license. In almost every case, the curbstoner has no fixed place of business and fails to adhere to most of the accepted industry practices or customs. It is not known how much revenue the curbstoners generate, although industry officials acknowledge that the amount is significant. Since curbstoners do business illegally it is likely that their income from sales goes unreported.
State attempts to enforce licensing laws against curbstoners are hampered by a lack of personnel and money. Furthermore, with no fixed place of business, a curbstoner is often difficult to track. Signs of potential curbstoning include:
Multiple auto listings in a paper with the same phone number
Displays of multiple vehicles "for sale" in shopping centers or similar parking lots all with the same phone number
The Federal Truth in Mileage Act requires odometer statements to be retained by both the buying and selling dealers. Most states require that a licensed dealer maintain certain records, which must be available for inspection by the appropriate state licensing or regulatory agency. Information about the records a dealer is required to maintain in a particular state can be obtained from the state agency responsible for the regulation of independent dealers. (Normally this will be the state Motor Vehicle Division or the state Department of Revenue.) Aside from these state and federal requirements, other specific records that must be maintained will vary from state to state.
The sophistication of the accounting and records system (including record retention) will normally vary with the dealer's size and location. However, there are certain common industry practices that provide documentation for a sales transaction. These practices will vary from state to state, since each state has different record retention requirements, but the basics will be the same. These industry practices are discussed in the various sections on income recognition and inventory. Currently, there is no overall computer accounting program specifically designed for independent dealers, however, there are many programs that are used by dealers.
The key record of a car sale is the car jacket, customer file, or deal jacket. A separate file is normally maintained for each sale. Many dealers create a deal jacket whenever a vehicle is purchased and assign a stock number to the vehicle. In that case, the deal jacket may also be used to track the cost of the vehicle and the cost of reconditioning the vehicle for sale. The file generally contains:
Cash Sale (No Trade-in)
Sales with Trade-ins
The customer file may be a separate manila folder, an envelope with the information in it, or simply papers stapled together. All are acceptable methods of record retention. A dealer will normally also maintain cash receipts records that will show the cash received by the dealer on a daily basis. An analysis of the deposits will indicate the sources of the dealer's revenues, which could include:
Aside from customer trade-ins, the most significant source of inventory for dealers is an auction. Dealers use auctions both to buy and sell vehicles. Dealers use wholesale auctions, where only dealers are permitted to buy or sell. Most dealer transactions are handled by the wholesale auctions. Some states also permit retail auctions, which are open to the general public, and may be used by the dealers as well.
Each auction company is run independently, maintains different records, and has its own procedures. Some common rules and procedures used in the auction industry include:
Generally, each auction holds its general wholesale sale once a week. It is common for dealers to attend more than one auction a week since each auction offers different types of vehicles in varying price ranges for sale. Special manufacturer and fleet auctions are held at various times throughout the year.
Dealers often attend several auctions a month, many of which are in another state. By attending auctions outside of his or her area, a dealer is able to take advantage of better market conditions for a specific type of vehicle. For example, a dealer in Florida may want to purchase convertibles, which may have a high price in the Florida market. However, a Wisconsin auction may offer convertibles for sale at much lower prices due to the lack of demand there. The Florida dealer will travel to Wisconsin, buy the convertibles, and profit from their sale to customers in Florida. Thus a dealer from one part of the country can benefit from obtaining vehicles at an auction in another part of the country.
While the overwhelming number of dealers may have a valid business reason for attending out-of-state auctions, such practices are also a compliance concern. A few dealers have been found attending out of state auctions to facilitate buying and selling vehicles "off the books."
The starting point of an auction is the registration of the dealers participating in the auction whether they are buying or selling. The auction generally requires that the dealer be registered in advance. This usually involves obtaining a copy of the dealer's license.
Once registered a dealer may participate in an auction. The selling dealer will provide the auction with the appropriate information about the vehicles offered for sale, as discussed previously. The vehicles will be assigned a number, which will be displayed on the windshield, and offered for sale. Since the seller has the right to set a floor price below which the vehicle may not be sold, not all vehicles offered for sale at an auction are sold. However, on average roughly 50 percent of the vehicles in a regular wholesale auction will be sold.
Once a buyer has successfully bid on a vehicle at auction, he or she is afforded an opportunity to inspect the vehicle to be sure that all representations about the vehicle made by the seller are correct. If there are no problems, the buyer then proceeds to settlement, and gives the auction his or her check for the purchase price. The auction fills in the title in the buyer's name and delivers the title to the buyer.
On the other side of the transaction, the seller will sign the title and deliver it to the auction for completion. The seller will then receive an auction check, with the restrictions noted below. Each party will also receive an invoice (Block Ticket) that shows the vehicle sold, as well as the identities of the seller and buyer. The auction invoice will also usually include an executed odometer statement.
The auction will not usually issue payment to a dealer without proof that a business bank account exists. Additionally, the auction normally provides restrictive endorsements on the check issued to the dealer to be certain that the proceeds are deposited to that account. For example, an auction will not issue a check to an individual, but will issue the check in the individual‘s business name. The check will normally bear some restrictive endorsement on the back, such as, "For Deposit to Account of Payee Only." Many auctions request a copy of a dealer's check to verify with the bank that the dealer actually has an account there.
Since the auctions guarantee that vehicle titles are lien-free, the auctions handle all title issues to ensure that the transfer is made correctly. Some common title problems include incorrect VIN, unsatisfied liens, incorrect title assignments, and an incomplete chain of title. The auctions have a great deal of experience with interstate transactions and generally have a very good working relationship with the various states Motor Vehicle Divisions.
Titling Issues and Processes
Titling procedures are determined by state law; thus there are 50 different sets of rules that apply. The state Division of Motor Vehicles, or similar agency, regulates the issuance and transfer of a vehicle‘s title and maintains a record of the owner. This information is available, although its usefulness in tracking an unreported sale or sales will depend on the database used by that particular state. In most states dealer-to-dealer transfers of title are accomplished through dealer reassignments. These reassignments are not usually recorded unless the state issued the original title or is recording the title once the vehicle is ultimately sold to a retail customer. All of these issues are compounded by the tremendous amount of interstate sales that occur. Although the use of state title transfers does have drawbacks and cannot be used to reconstruct or determine all of a dealer's sales, it remains a useful tool in checking the accuracy of reported sales. Despite no uniformity in titling rules or procedures, some very basic elements exist in all states:
Generally, title to vehicles purchased at an auction is reassigned directly from the seller to the buyer, although some states require the auction to note on the reassignment of title that the transaction is an auction sale. Some dealers may also purchase vehicles purchased in Canada. Canadian titling laws are much different from those in the United States, and advice on procedures should be sought from an international examiner, who can put you in contact with the Revenue Service Representative for Canada. Do the same with any dealer transactions in Mexico.
In most states, dealers need not take actual title to a vehicle, but can reassign the title. This may be done on the title, or on a separate sheet attached to the title. The significance of reassignment is that the dealer will not have to register the title with the Motor Vehicle Division until the vehicle is sold "at retail" to a non-dealer customer. This can make tracking the sale of a vehicle very difficult.
Example of titling
A dealer in Virginia takes a vehicle with a Maryland title in trade on a sale. The dealer then sells the trade-in at a North Carolina auction, where the title is reassigned to the North Carolina dealer who acquires the vehicle. That dealer then sells the vehicle to a Florida dealer with a reassignment of title.
The Florida dealer then sells the vehicle to a New York dealer, again reassigning the title. Finally, the New York dealer sells the vehicle to a California dealer, by yet another title reassignment. The California dealer then sells the vehicle to a California resident. The State of California will issue the new title to the retail purchaser. California may notify Maryland, the state with record of the original title, of the new title. Maryland would then cancel the original title. The notice may show all of the reassignments. However, no title record of the vehicle's sales will appear in any of the intervening states. The Virginia, North Carolina, Florida and New York Motor Vehicle Divisions will not record the vehicle being sold in their state. However, each dealer should have a deal jacket for the transaction involving the vehicle.
Workbook on Reporting Cash Payments of over $10,000
The law requires that trades and businesses report cash payments of more than $10,000 to the federal government by filing IRS/FinCEN Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business This workbook helps determine what transactions a business must report and how to report them and also addresses the civil and criminal penalties that might apply for noncompliance with the rules.
The law requires that trades and businesses report cash payments of more than $10,000 to the federal government by filing IRS/FinCEN Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business (See Exhibit 1, Form 8300).
Transactions that require Form 8300 include, but are not limited to:
The information contained in the form assists law enforcement in its anti-money laundering efforts. When businesses comply with the reporting laws they provide authorities with an audit trail to stop tax evasion, drug dealing, terrorist financing, and other criminal activities.
Trades and businesses must report cash payments received, if all of the following criteria are met:
Cash includes the coins and currency of the United States and a foreign country.
Cash may also include cashier’s checks, bank drafts, traveler’s checks, and money orders with a face value of $10,000 or less, if the business receives the instrument in:
Example: Tom Greenwood purchases a used car from XYZ Auto Dealership for a total of $12,000. He pays with a cashier’s check having a face value of $12,000. The cashier’s check is not treated as cash because its face value is more than $10,000. The business does not need to file Form 8300.
A designated reporting transaction is the retail sale of any of the following:
Example: Ed Johnson asks a travel agent to charter a passenger airplane to take a group to a sports event in another city. He also asks the travel agent to book hotel rooms and admission tickets for the group. He pays with two money orders, each for $6,000. The travel agent has received more than $10,000 cash in the designated reporting transaction and must file Form 8300.
Cash does not include personal checks drawn on the account of the writer.
Cash does not include a cashier’s check, bank draft, traveler’s check, or money order with a face value of more than $10,000. When a customer uses currency of more than $10,000 to purchase a monetary instrument, the financial institution issuing the cashier’s check, bank draft, traveler’s check, or money order is required to report the transaction by filing FinCEN Form 104, Currency Transaction Report.
Example: Jim Roberts purchases an automobile from ABC Auto Dealers for $19,000. He pays with $4,000 in currency and a personal check in the amount of $15,000. Since a personal check is not considered to be cash, ABC Auto Dealers does not need to file a Form 8300.
Cash does not include a cashier’s check, bank draft, traveler’s check, or money order that is received in payment on a promissory note or an installment sales contract (including a lease that is considered a sale for federal tax purposes). However, this exception applies only if:
Cash does not include a cashier’s check, bank draft, traveler’s check, or money order that is received in payment for a consumer durable or collectible, and all three of the following statements are true:
Cash does not include a cashier’s check, bank draft, traveler’s checks, or money order received for travel or entertainment if all three of the following statements are true:
The law requires that trades and businesses report transactions when customers use cash in a single transaction or a related transaction. Related transactions are transactions between a buyer, or an agent of the buyer, and a seller that occur within a 24 hour period. If the same buyer makes two or more transactions totaling more than $10,000 in a 24 hour period, the business must treat the transactions as one transaction and report the payments. A 24 hour period is 24 hours, not necessarily a calendar day or banking day.
Example: A retail motorcycle dealer sells a motorcycle for $9,000 in cash to Gary Smith at 10:00 a.m. During the afternoon on the same day, Mr. Smith returns to buy another motorcycle for his son and pays $9,000 in cash. Since, both transactions occurred within a 24 hour period, they are related transactions, and the motorcycle dealer must file Form 8300.
Transactions are related even if they are more than 24 hours apart when a business knows, or has reason to know, that each is a series of connected transactions.
Example: A client pays a travel agent $8,000 in cash for a trip. Two days later, the same client pays the travel agent $3,000 more in cash to include another person on the trip. These are related transactions, and the travel agent must file Form 8300.
Example: A customer purchases a vehicle for $9,000 and then within the next 12 months pays the dealership additional cash of $1,500 for items such as a new transmission, accessories, customized paint job, etc. The dealership is not required to file a Form 8300, if the additional transactions are not part of the original sales contract and the customer has no additional legal obligation to make such additional transactions.
There may be situations where the business is suspicious about a transaction. A transaction is suspicious:
The business should report suspicious activity by checking the “suspicious transaction” box (box 1b) on the top line of Form 8300. Businesses are also encouraged to call the IRS Criminal Investigation Division Hotline at 1-800-800-2877 or the local IRS Criminal Investigation unit. If a business suspects that a transaction is related to terrorist activity, the business should call the Financial Institutions Hotline at 1-866-556-3974.
The business may voluntarily file a Form 8300 in those situations where the transaction is $10,000 or less and suspicious.
The amount of cash a customer uses for a transaction, and when the customer makes the transaction are the determining factors for when the business must file the Form 8300.
Generally, a business must file Form 8300 within fifteen days after the customer makes the payment. If the fifteenth day falls on a Saturday, Sunday, or holiday, the business must file the report on the next business day.
In some situations, the buyer may arrange to pay in cash installment payments. If the first payment is more than $10,000, a business must file Form 8300 within 15 days. If the first payment is not more than $10,000, the business adds the first payment and any later payments made within one year of the first payment. When the total cash payments exceed $10,000, the business must file Form 8300 within 15 days.
After a business files Form 8300, it must start a new count of cash payments received from that buyer. If a business receives more than $10,000 in additional cash payments from that buyer within a 12-month period, it must file another Form 8300 within 15 days of the payment that causes the additional payments to total more than $10,000.
If a business must file Form 8300 and the same customer makes additional payments within the 15 days before the business must file Form 8300, the business can report all the payments on one form.
Example: On January 10, a customer makes a cash payment of $11,000 to a business. The same customer makes additional payments on the same transaction of $4,000 on February 15, $5,000 on March 20, and $6,000 on May 12. By January 25, the business must file Form 8300 for the $11,000 payment. By May 27, the business must file another Form 8300 for the additional payments that total $15,000.
A business should file Form 8300:
IRS Detroit Computing Center
P.O. Box 32621
Detroit, MI 48232
When a business files a Form 8300, the law requires the business to provide a written statement to each person named on Form 8300 to notify them that the business has filed the form.
The statement must include the following information:
The code and regulations only specify the information that the business is required to include on a statement, not the format of the statement. A business may use its invoice for the statement of notification, as long as the invoice includes all required information. Providing a copy of Form 8300 to the payee(s), although not prohibited, is not advisable due to the sensitive information contained on the form, e.g., Employer Identification Number (EIN) or Social Security Number (SSN) of the filer.
The business must provide the written statement to its customers on or before January 31 of the year after the year in which the customer made the cash payment that caused the business to file Form 8300. A business that chooses to mail the statement must mail the statement timely to ensure the customer receives the statement by January 31.
A business should keep a copy of every Form 8300 it files and the required statement it sent to customers for at least five years.
Businesses may be subject to civil and criminal penalties for noncompliance with the law.
Civil penalties and applicable rules are:
A person may be subject to criminal penalties for:
Any person required to file Form 8300 who willfully fails to file, fails to file timely, or fails to include complete and correct information is subject to criminal sanctions as a felony under IRC Section 7203. Sanctions include a fine up to $25,000 ($100,000 in the case of a corporation), and/or imprisonment up to five years, plus the costs of prosecution.
Any person who willfully files a Form 8300, which is false with regard to a material matter, may be fined up to $100,000 ($500,000 in the case of a corporation), and/or imprisoned up to three years, plus the costs of prosecution. (IRC Section 7206(1))
The penalties for failure to file may also apply to any person (including a payer) who attempts to interfere with or prevent the seller (or business) from filing a correct Form 8300. This includes any attempt to structure the transaction in a way that would make it seem unnecessary to file Form 8300. “Structuring” means breaking up a large cash transaction into small cash transactions.