Inventory Deferral of Profit

[Snaggletooth]

Let me toss this one out to the group for opinions.

A couple dealers in the used car business (emphasize these are established dealers and not sleaze fly-by-night people) have insisted that they are able to do the following:

Defer the gross profits made on their sales, to the extent represented by the build-up of inventory, and consider the cash investment as an OPERATING EXPENSE until a five-year period has expired. Example: Sales $1,000,000, Cost of Sales, $600,000, Overhead expenses $300,000, Taxable Income $100,000.

This doctrine says that as long as the inventory buildup is $100,000 or more, then the $100,000 can be reported as an operating expense, and the profit deferred until the next year. This mindset is industry-specific to dealers of vehicles/equipment only, and not in general applicable to all businesses.

Please let me have your opinion, and please no used car salesman jokes. Although many of them may be scoundrels, many of them are in it to make a serious living and wish to build a decent reputation with repeat customers.

[BHoffman]

Snags - here is a link to IRS audit guide. I suppose if your client is going to be examined, this is what they would be looking at:

http://www.irs.gov/businesses/small/article/0,,id=141495,00.html

I print these industry-specific audit guides and give them to my clients.

[Snaggletooth]

Relevant Response

Ms. Hoffman thanks for your usual helpful response, and the link to the audit guide. Problem is I won't have 1 out of 50 clients read a 28-page document that they don't understand to begin with. The audit guide, however, is useful to me in the context of industry-specific topics.

And it doesn't address the question of reclassification of inventory expenditures to an operating expense. Frankly, I'm afraid this may be an urban myth, and my client may simply have to exercise conventional inventory control just like any other merchandise business. But I wondered if any board members had any exposure to this. In my many years, if such a thing were allowed, I think I would have heard about it by now.

Simply put, he has applied all available spare cash to building an inventory which is turning very well, The client has not spent his cash on churlish and foolish expenses, and has put his money where he believes profit will occur. We are exploring whether there is any legitimate tax relief available.

[MLINDER42]

Used Car Inventory

Having been in the new car and used car field for years before becoming an EA this is an urban tale that I have argued about for years.I have several friends who I refuse to do their returns for this reason.What I do adhere to is restating the inventory to current wholesale value on 12/31 which is usually lower at that time and taking a inventory loss.Cars usually go back up in the spring this is a way of delaying the report of profits.

[JON]

Years ago

I used to audit some new car dealships. Used cars received on trade-ins could be valued as above. The reason was if you looked at the trade-in value on the sale who knew what was a disount off of retail and what was really the trade-in value. I did not think that if you purchased directly a used car for your inventory you could adjust that cost. I never liked auditing and that is why I stopped 20 years ago.

[Snaggletooth]

Write-down of Goods?

Thanks for these good and helpful pointers.

If the inventory is written down because of a market decline at 12/31 or because of a high trade-in cost, should we check line 9b on Schedule A (of 1120)? This indicates a write-down of subnormal goods.

What are the ramifications if a corporation claims a write-down of subnormal goods??

[Black Bart]

Let me toss this one out to the group for opinions.

A couple dealers in the used car business (emphasize these are established dealers and not sleaze fly-by-night people) have insisted that they are able to do the following:

Defer the gross profits made on their sales, to the extent represented by the build-up of inventory, and consider the cash investment as an OPERATING EXPENSE until a five-year period has expired. Example: Sales $1,000,000, Cost of Sales, $600,000, Overhead expenses $300,000, Taxable Income $100,000.

This doctrine says that as long as the inventory buildup is $100,000 or more, then the $100,000 can be reported as an operating expense, and the profit deferred until the next year. This mindset is industry-specific to dealers of vehicles/equipment only, and not in general applicable to all businesses.

Please let me have your opinion, and please no used car salesman jokes. Although many of them may be scoundrels, many of them are in it to make a serious living and wish to build a decent reputation with repeat customers.

I (and you) know of MLINDER's "write-down of inventory", but I've never heard of the method your guys are talking about .

Here's something I ran across: "As prices and inventory levels rise, the LIFO method creates expense for dealerships by increasing COGS and decreasing the value of the inventory...dealers that have not been on used LIFO for more than five years are eligible to re-elect to use this method in 2009...

Could this be the "five years" your guys are talking about?

Google "Year-End Planning May Reduce Dealer Taxes: LarsonAllen LLP"

[Maribeth]

Thanks for these good and helpful pointers.

If the inventory is written down because of a market decline at 12/31 or because of a high trade-in cost, should we check line 9b on Schedule A (of 1120)? This indicates a write-down of subnormal goods.

What are the ramifications if a corporation claims a write-down of subnormal goods??

Would not your inventory method simply be lower of cost or market. I don't see how you adjustment, in this case, would be a write-down of subnormal goods.

Maribeth

[Snaggletooth]

Thanks

...to all who have responded to this thread.

Apparently, there are lurking amongst car dealers with an erstwhile delusion of tax preparation, a number of myths involving various theories about what can be done with inventories over a five-year period.

The "lower of cost or market" theories advanced above for depressed 12/31 values and over-market trade in costs do offer some helpful advice.