After a brief reprieve due to the pandemic, state and local tax audits are back in full force with automotive dealerships being a top target. While nobody enjoys getting the dreaded letter from a state revenue department, there are things you can do to prepare and bolster your documentation, tax reporting, and remittance procedures for state tax auditors should they come knocking. Here are four key audit areas automotive dealership leaders should focus on for improving your dealership’s tax and financial documentation.

1. Sales and gross receipts

   While most dealerships file sales tax returns with financial information derived from their dealer financial statements, state tax auditors will often commence the audit by attempting to reconcile or point out inconsistencies between information reported on your quarterly returns with figures reported on your state income tax returns. While there may be several legitimate reasons for differences between the figures, an auditor will likely require you to provide a reconciliation explaining any differences. It is worth looking at your dealership’s financial statement mapping of sales to make sure it includes all sale accounts that would otherwise be grouped for tax purposes.

2. Fixed assets

   You should keep all of your fixed asset invoices to prove that sales tax was paid and capitalized to the asset. In the event the vendor does not charge you sales tax and the item at issue is taxable, you should be accruing applicable use tax and paying it with your next quarterly return. Auditors will also target repairs and maintenance accounts. You should have a copy of your capitalization policy and be prepared to explain how items are deemed to be repairs versus capitalization.

3. Advertising costs subject to sales tax

   A highly targeted area of dealerships is advertising costs. It is important to look at your advertising bills and understand what is and is not taxable in your state. Since advertising is generally a nontaxable service, many vendors do not charge sales tax on their invoices to dealerships. However, if the advertising involves printed mailers or advertising inserts for periodicals and circulars to be distributed to prospective customers, that form of advertising could very well be taxable. In addition, many digital and online advertising or listing services could be considered to involve the sale of a taxable information service or in some cases, access to a cloud computing portal which may be taxable as well. Therefore, it is imperative that you review your invoices in detail to understand the nature of the service and how it is delivered. If there are outstanding questions on the advertising services you purchased, seek additional clarification with your vendors.

4. Loaner vehicles and repairs or maintenance

   Another confounding area in sales tax for a dealership to consider is how to treat loaner vehicles provided to customers. Confusion can appear when trying to identify whether there is a charge for the loaner and whether part of a free or additional warranty or maintenance program can impact the taxability. Additionally, there are also states that will not permit a dealership to purchase a loaner vehicle with a tax-free resale certificate since the vehicles may be utilized by the dealership and not sold or leased to customers.
   
   Lastly, the treatment of repairs and maintenance is an additional layer of complexity for dealerships to properly account for when it comes to sales and use tax. Whether to charge sales tax on repairs or maintenance done under a warranty (or without a warranty), how to treat inspection charges, and whether to include towing charges and environmental or hazardous waste fees in the taxable sales price are all examples of difficult sales tax questions that dealerships and their owners face regularly. In light of these potential problem areas, it is imperative that your accounting and invoicing departments are provided with the correct taxability rules and determinations.

There are many other areas where dealerships can potentially enhance and solidify their sales tax processes. State tax audits can come with penalties and interest which can significantly accrue over time depending on the look-back period under review by the state (usually three to four years). It is recommended to get your CPA/tax advisor involved early and often so that you can avoid surprises and impossible requests to satisfy due to a lack of documentation and failing to implement appropriate procedures and controls.

How Citrin Cooperman can help

Citrin Cooperman’s Automotive Dealerships Industry Practice is comprised of a team of professionals who specialize in helping dealers grow their businesses and work closely with our State and Local Tax (SALT) team to ensure automotive dealerships are up to date with their state tax compliance obligations. If you have any questions, please contact Philip Craft at pcraft@citrincooperman.com or Jaime Reichardt at jreichardt@citrincooperman.com.