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Insights for dealership owners and executives
In this issue, we explore some
major issues facing dealers today.
2
IRS proposed regulations provide
potential opportunity to increase cash flow
3
Tool plans on the IRS hit list:
Did the taxpayer really hit back?
Tax update: Estimated tax payments
4
UNICAP update
5
Passive activity loss rules:
A taxpayer win for LLPs and LLCs?
Cash flow has become an urgent matter
Cautious optimism?
By Brad Nicklin, CPA
March 2010
I frequently meet with industry leaders and often get the question, “What is going on in
the auto industry right now?” Here is what I would say to them. 2010 is here, and we
have more optimism in the auto markets than we have had over the past 12-18 months.
Why is this? I think consumers are starting to feel a little better about their jobs and the
prospects of having them in the near term. The endless string of massive layoff headlines
has subsided. The banks are starting to provide credit, and the financial system
seems to have stabilized. Fourth quarter earnings from the corporate stalwarts are
meeting or exceeding expectations which has pushed the stock markets higher from
their March 2009 lows.
Specific to the Washington area auto industry, I recently attended the Washington Area
Auto Show and found that there was more consumer enthusiasm than I expected.
Consumers were walking around with comparison sheets displaying to me they were
approaching a decision. Some of the alternative brands seem to have some momentum
(Hyundai, Subaru). I stood by the Hyundai display for quite a while and heard very favorable
comments about their quality, reliability, warranty and Consumers Reports ratings.
Ford is strengthening their market presence and had quite an impressive display of
vehicles. Several of our Ford dealers had a strong 2009. We are also seeing used car,
parts, and service operations holding their own and providing healthier gross margins.
Generally speaking, the local auto dealers are weathering the storm fairly well. I think
one of the most important parts of the optimism is the fact dealers have reduced costs
so much that they are really feeling the full effects of the cuts they made in the fourth
quarter of 2008. The current interest rate environment has been extremely favorable
to dealer bottom lines. Questions will loom on how Toyota will weather the recalls and
halting sales. This will offer opportunity and anxiety in the dealer body.
Many dealers are returning from the NADA Convention with new ideas of how to be
more efficient and use technology to their advantage. Specifically, I saw systems that
enhanced service department revenue, accountability, and monitoring with easy-touse
tools that help the service manager run a more profitable department. The one
that I saw was certainly very comprehensive. Social networking and internet presence
continues to be an important part of any dealer marketing campaign. Technologies
to support these marketing efforts were abundant. The floor was certainly busy, and
continued on page 6

The new proposed Regulation 1.263(a)-3
provides guidance on how some capital
assets costs could be treated differently
for tax purposes—that is generally
favorable to taxpayers.
page 2
IRS proposed regulations provide potential
opportunity to increase cash flow
By Scott Barnard, CPA
The opportunity
Staying competitive requires substantial recurring capital outlays. Maintaining equipment,
replacing worn-out fixtures, reconfiguring tenant spaces, maintaining and repairing roofs,
and upgrading to a new franchise image are just a few examples of the costs that business
owners incur. In the past, tax law did not provide clear direction
on how to treat these costs. Since the costs relate to capital
assets, most taxpayers conservatively considered them building
components, typically depreciating them over 39 years. Proposed
Regulation 1.263(a)-3 now provides guidance on how these costs
should be treated for tax purposes. The guidance is generally
favorable to taxpayers, because it may allow these items to be
deducted currently as repairs and maintenance expenses, rather
than depreciated over long periods.
Benefits
There are two benefits that result from the ability to currently expense costs that would
otherwise be capitalized and depreciated. The obvious benefit is that a deduction that
reduces taxable income today is worth more than a deduction in the future due to the time
value of money. Currently deducting amounts that otherwise would be depreciated over 15
or 39 years can easily return up to $25 for each $100 spent. The less obvious benefit is
that reclassifying these costs as repairs and maintenance allows you to avoid depreciation
recapture when you eventually dispose of the property. By avoiding depreciation recapture,
you can convert ordinary gains into capital gains, which are currently taxed at lower rates.
This can provide another $5 to $10 of return for each $100 spent.
Solutions
The ability to deduct the types of costs discussed above will depend on your particular
facts and circumstances, and will require proper analysis and documentation to meet the
requirements of the proposed regulations. Analyzing your repairs and maintenance costs
will:
> Provide you with the opportunity to structure current and future projects for maximum tax
benefits
> Allow you to review projects completed in prior years to consider if remaining depreciable
basis can be deducted currently
Baker Tilly welcomes the opportunity to help you analyze your situation and determine if
you can benefit from this provision of the tax law.
Please contact Scott Barnard at 703 923 8555 to discuss this planning
opportunity.
Baker Tilly Dealer Network

Tax Update
Estimated tax payments:
According to a July 9, 2009 notice posted to the IRS website
at www.irs.gov/formspub/article/0,,id=208130,00.html,
qualified individuals with small businesses may be eligible to
make smaller estimated tax payments in 2009 – the smaller
of 90% of the tax shown on the 2008 tax return or 90% of the
tax shown on the 2009 tax return. To be a qualified individual,
(1) more than 50% of the person’s gross income must be from
a business that had an average of fewer than 500 employees
in 2008, and (2) the person’s adjusted gross income in 2008
must have been less than $500,000 ($250,000 if married
filing separately for 2009).
Tool plans on the IRS hit list:
Did the taxpayer really hit back?
By Karen Myrick, CPA
The IRS has repeatedly attacked the use of tool plans as a means of avoiding taxes. The
IRS recently blessed a taxpayer’s reimbursement plan, but the ruling provides little practical
guidance for taxpayers. The plan at issue addressed the IRS’s previous concerns and
followed the existing requirements exactly.
Background
Under an acceptable tool plan, an employer may reimburse an employee for the cost of
his tools tax-free, if the plan requires that (1) the tools be used for the employer’s business
and be deductible as a business expense, (2) the employee maintains adequate substantiation
of the expense, and (3) any excess reimbursements be returned to the employer.
PLR 200930029
The plan in question had the following features:
Business connection – The Tool Plan only covered expenses incurred during the current
plan year and on job assignments while employed with the current employer. Tools and
equipment must be maintained at the employer’s place of business and must be considered
necessary for the industry.
Substantiation – Employees must submit a claim form that certifies that the purchased
item meets the requirements listed above and identifies the job assignments requiring
the expenses. The employee must submit acceptable proof of
purchase that includes the item description, date of purchase, and
cost within 30 days of purchase.
Repayment – The plan does not allow cash advances, so there
should not be excess reimbursements. However, it states that
erroneous reimbursements must be returned within 30 days.
Other – The Tool Plan required the employer to determine a
maximum reimbursement limit per employee at the beginning of
the year. The employer stated that reimbursements are not made
as part or instead of compensation. The plan did not provide
adjustments to compensation on account of reimbursements.
Although it is encouraging that the IRS did not dispute the plan
above, it is hardly informative for taxpayers seeking guidance for
terms not falling squarely under the rule. To use the Tool Plan as a
guide would likely require employers and employees to change the
terms of their current agreements.
page 3 Baker Tilly Dealer Network

UNICAP update
By Scott Barnard, CPA
Dealers are subject to the Internal Revenue Code Sec. 263A uniform capitalization (UNICAP) rules. These rules call for additional indirect
costs to be capitalized into inventory that would not normally be capitalized under the traditional Sec. 471 full absorption cost accounting
provisions. As a result, dealers may be required to treat certain costs that would otherwise be deducted as inventory costs. The typical
inventory related costs that might be capitalized are purchasing, handling, and storage. Historically, we have advised many of our clients to
adopt specific, simplified UNICAP methods. The use of these methods and meeting certain safe harbors can result in a zero UNICAP adjustment
– no additional costs need to be capitalized.
The IRS has been pursuing new UNICAP theories and contending
that dealers should be capitalizing even more costs under the
premise that dealerships are not retail businesses and are instead
producers. The UNICAP rules for producers can capture more
expenses than for retailers.
These challenges have occurred during IRS audits even though
there have been no legislative or regulatory changes in this area.
Although, the IRS continues to suggest that a Revenue Ruling will
be issued in the near future addressing these issues. Revenue
Rulings apply to all taxpayers and have regulatory authority.
What’s new
The IRS issued a directive to their audit branch last fall suspending
the examination of auto dealership UNICAP issues effective Sept.
15, 2009, through Dec. 31, 2010. The suspension is designed to
give auto dealers a chance to voluntarily change their accounting
methods to come into compliance with IRS guidance issued in
2007. During this period, examiners are instructed not to raise
these issues on auto dealership examinations. Those auto dealership
exams in process as of Sept. 15, 2009, may continue to
develop UNICAP issues. Effective Jan. 1, 2011, the IRS says
exams of auto dealership UNICAP issues will resume.
2007 guidance
In a Technical Advice Memo (TAM) issued as PLR 200736026, the
IRS rejected an auto dealer’s hybrid self-developed method of capitalizing
additional UNICAP costs and set forth in detail its views on
how a typical auto dealer should handle costs, including repair/
installation of parts on customer owned cars (treated as handling
costs, not as a production activity), installation by the dealer or
a subcontractor of parts to new and used vehicles owned by the
dealer (these constitute production activities), and storage costs
(depends on whether on-site or off-site). PLR’s are only applicable
to the taxpayer under audit.
The IRS has classified auto dealership UNICAP issues
as a Tier III issue (risks that represent the highest
compliance risk for a particular industry)
because of a high level of perceived
taxpayer noncompliance and developed
a number of audit tools for examiners.
What’s next
Each dealer will need to consider whether and when to change
its tax accounting method during and beyond this moratorium. In
making that decision, a dealer will need to consider the following
pros and cons.
Pros
> Opportunity to spread any income increase from the change
over four years.
> Avoid exposure to penalties and interest.
> Proactive change may result in a lower amount of
capitalization than under an audit.
> Audit protects the issue but the calculation would still be
subject to challenge.
Cons
> Costs to initiate the accounting method change.
> Increase in capitalization over current method.
> Additional complexity of future annual calculations.
> Higher tax burden.
The reasoning behind the IRS view change in this area remains
unclear, as well as the technical basis for the change. As
mentioned, there have been no legislative or regulatory changes,
and the PLR only applies to that particular taxpayer. Additionally,
many dealers filed automatic accounting method changes with the
IRS in prior years adopting the safer harbor methods referred to
above that resulted in “zero” UNICAP adjustments. Furthermore, it
is not completely clear how to apply the IRS guidance suggested
in the PLR and developed in their audit toolkit.
We are recommending that dealers continue to monitor this issue.
We anticipate further guidance as a result of industry/ IRS
discussions or via a revenue ruling. Whether, or if, the guidance
comes before 2011 is anybody’s guess.
Dealers should anticipate the need to file for some
type of UNICAP accounting method change in the
foreseeable future.
page 4 Baker Tilly Dealer Network

Passive activity loss rules: A taxpayer win for LLPs and LLCs?
By Karen Myrick, CPA
Background
Under section 469, passive activity losses are limited to passive
activity income and cannot offset nonpassive income items such
as wages and dividends. Generally, a determination that an activity
is passive is based on whether the partner materially participates.
However, certain limited partnership interests are presumed
passive activities by definition. The IRS previously took the
position that all ownership interests in other limited liability entities
– such as limited liability companies (LLCs) and limited liability
partnerships (LLPs) – were also passive activities under the same
definition. According to the IRS, such interests met the definition
of a limited partnership interest because all of the interests in
question enjoyed limited liability.
Garnett v. Commissioner
In Garnett v. Commissioner,132 T.C. No. 19, the Tax Court
disagreed. The Court noted that limited liability may define all
three entities as “limited partnerships” for purposes of the passive
activity rule enumerated above, but the rule also requires that the
owner be a “limited partner.” The presumption also has an exception:
a taxpayer that owns both a general partner interest and
a limited partner interest will not fall under the presumption. The
Cash flow has become
an urgent matter
By Brad Nicklin, CPA
With the current state of the economy, it is time to take a
close look at how to better manage cash. By analyzing current
processes around cash management and implementing even
small changes to those processes, you can reduce your
interest costs and increase cash flow of the dealership.
Two of the best ways to increase cash flow is to bill regularly
and closely monitor receivables. Speeding up the process
starts when the receivable is generated. Bill daily for manufacturer
warranty, incentives, and all other receivables. Make
sure the documentation for the receivable is adequate and
complete, otherwise unnecessary delays will occur. Consider
centralizing the billing process as well. This will reduce costs
and increase efficiencies. Once billed, the accounting staff
needs to be reviewing on a daily basis outstanding balances in
contracts in transit, vehicle receivables, accounts receivable,
factory receivables such as warranty claims, incentives, predelivery,
finance and insurance reserves, and other receivables.
When evaluating the receivables, use the aging to ensure the
main difference between the two interests is the partner’s ability
to participate in the management of the entity. The Court found
that the rule as written presumes no material participation on the
part of a limited partner of a limited partnership based on the
limitations inherent under state law with that ownership interest.
An owner of a LLC or LLP is not inherently prohibited from materially
participating in the entity’s business. Therefore, the Court held
that ownership interests in LLCs and LLPs are general partner
interests for purposes of the presumption discussed above.
Practical considerations
Generally, the Garnett decision is a win for taxpayers who own
interests in LLCs and LLPs. This should provide more flexibility
to dealers in structuring ownership of franchises and the underlying
real estate. Dealers typically own dealership real estate in a
separate LLP or LLC. The real estate operations may or may not
be passive depending on ownership and whether the real estate
entity generates taxable income or loss. These rules remain
complex and require careful planning based on individual taxpayer
facts. We have considerable experience structuring the ownership
of dealerships and the underlying real estate to minimize or
eliminate the deferral of losses under the passive loss rules.
oldest are being worked the hardest. Do not just focus the
attention on the old receivables, as all receivables over the
established age benchmark should be worked. Cash flow will
be increased by simply speeding up the billing process and
concentrating on the collection of the receivables.
Poor inventory management can have a negative impact
on cash flow. With the slowed economy, inventories have
ballooned due to lack of sales. As dealers are trying to work
their way out of the inventory they have on their lots, it is
important to avoid the temptation of accepting additional
allocation, even if offered some extra money to accept. The
time it would take you to sell additional vehicles is unknown,
and the risk is likely not worth the expense. Having a reasonable
days sales inventory limit on used (45 days or lower) and
new (60 days or lower) vehicles is the most effective way to
manage your business. Discipline and accountability is the key
to achieving great results and reasonable inventory levels.
Time will be the determinant of how this whole crisis will shake
out. Being cautious with cash, relentless on collecting receivables
and managing inventory to appropriate levels will only
make the dealership stronger during these difficult times.
page 5 Baker Tilly Dealer Network

Dealer Network
Cautious optimism?
continued from page 1
Erich Merkle, President of Autoconomy, is
predicing 12.5 million new units in 2010.
Dealer Network is published by Baker Tilly as a source of information for clients and
business associates. You may reprint this article for the benefit of your customers
and/or employees—but must include the author’s name and “© Baker Tilly Virchow
Krause, LLP.”
Dealership Specialists
Contact us with questions and/or newsletter topic suggestions. Visit our web site
for a complete list of offices.
www.bakertilly.com autocpa@bakertilly.com 800 362 7301
Washington, D.C.
Scott Barnard, CPA scott.barnard@bakertilly.com 703 923 8555
Bradley Nicklin, CPA bradley.nicklin@bakertilly.com 703 923 8596
Ed Offterdinger, CPA ed.offterdinger@bakertilly.com 703 923 8608
Midwest
Richard Warnke, CPA richard.warnke@bakertilly.com 608 240 2640
Mike Krueger, CPA mike.krueger@bakertilly.com 612 876 4614
Michael Mader, CPA, CFE michael.mader@bakertilly.com 920 739 3329
Ryan Maniscalco, CPA ryan.maniscalco@bakertilly.com 414 777 5538
Brent Wagner, CPA brent.wagner@bakertilly.com 608 240 2403
Tom Minielly, CPA thomas.minielly@bakertilly.com 248 368 8809
ILLINOIS | MICHIGAN | MINNESOTA | NEW YORK | WASHINGTON D.C. | WISCONSIN
the vendors seemed to really have it down this year by having plenty of space to provide
meaningful product demonstrations. The vendors seemed to be very busy, which tells me
dealers are ready to invest in their business again. That may be the
right move given many are predicting that 2009 will represent the
bottom for the automotive industry. Erich Merkle, President of Autoconomy,
showed the Auto Team America CEO/CFO Forum participants
many historical slides proving that we should expect to see
more new car sales in 2010. He is actually predicting 12.5M new
units in 2010. Erich showed historical evidence the jobs issue will begin to turn positive in
the second to third quarter of 2010, but will rebound slower than in previous recoveries. We
are already starting to see some signs that corporate and consumer credit is beginning to
thaw. The combination of the two improving will make for what should be a stronger 2010.
That said, I think dealers have learned a lot in the past 18 months. One of the important
things to remember is to stay disciplined and remain lean as business begins to pick up.
This will continue to drive more to the bottom line.
There is no doubt this continues to be a challenging time for all businesses. But with all
the positive things that are beginning to happen, I believe there is a sense of cautious
optimism out there.
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promulgated by the United States Department
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by the Internal Revenue Service, and it
cannot be used by any taxpayer for such
purpose. No one, without our express
prior written permission, may use or refer
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should be sought. © 2010 Baker Tilly Virchow Krause, LLP