Dealers Discover Tax Break in Previously-Capitalized Trade Discounts

IRS Provides Dealers with Significant Tax Deduction Opportunity
Dealers who currently capitalize volume-related trade discounts may have a significant tax deduction awaiting them. Through a recent analysis of its nearly two thousand dealership clients, SourceCorp Professional Services, a Fort Worth-based firm specializing in Last In First Out (LIFO) accounting, found that the majority of dealerships capitalize such discounts and would benefit by changing the way they account for them.

"Virtually all automobile dealers receive trade discounts with the purchase of a vehicle -- Trade discounts are unconditional, non-inventoriable costs and must be reduced from the cost of vehicles," said Stanton Williams, president of SourceCorp Professional Services. "These receivables include flooring or finance credits, advertising assistance and prep and conditioning."

According to Williams, a dealership with 250 vehicles in year ending inventory can expect an average deduction of $250,000.

Issued earlier this year, Revenue Procedure 2002-9 provides automatic approval of Forms 3115 filed by taxpayers who wish to treat these discounts as a reduction in the cost of inventory. The procedure also defines "volume-related trade discounts" as discounts that meets the following criteria:
(a) the taxpayer receives or earns the discount solely as the result of the purchase of the merchandise to which the discount relates;
(b) the taxpayer is neither obligated nor expected to perform or provide any services in exchange for the discount; and
(c) the discount is not a reimbursement of any expenditure incurred or to be incurred by the taxpayer.

Additional good news to dealers was delivered by IRS shortly thereafter 2002-9. Rev. Proc. 2002-19 enables taxpayers to take 100% of the resulting tax deduction (a negative 481(a) adjustment) in the year of change, versus spreading the adjustment over a period four years as was previously required.

When SourceCorp Professional Services contacted Robert Jay, controller of the Phoenix and Santa Barbara based Mel Clayton Ford, he jumped at the chance to identify any current accounting practices that lowered taxable income.

"SourceCorp Professional Services helped us discover a substantial benefit that we did not know we had coming to us," said Jay. "We received a huge deduction and were able to take it all in one year,
thanks to the new rules."

For Jay Automotive Group, Inc. of Columbus Georgia, the change in its accounting methods resulted in a 2001 tax deduction of over $350,000.

"By taking advantage of this accounting change, we not only received a significant tax benefit, but were able to take the full benefit in one year," said Dana Sasser, controller of Jay Automotive. "LIFO Systems provided us with the Form 3115 and 481(a) adjustment." Because of the tax benefit it offers, SourceCorp Professional Services has encouraged its clients to change the way they account for trade discounts.

"Our clients look to us for ways save taxes and to stay in compliance with IRS rules," said Williams. "This change provides our clients with both-a substantial tax benefit and compliance with Revenue Ruling 84-41, which says a dealer 'must' reduce the cost of their inventory by the trade discounts."

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