After nearly five years, the IRS assault on dealerships to pay employment taxes on factory incentive bonuses paid to salespersons is over! Mary Baker, the IRS National Motor Vehicle Industry Specialist, announced a change in the IRS' position during the 5th annual AICPA National Auto Dealership Conference held in San Diego. She stated that employee incentive payments under facts similar to a prior IRS ruling are not subject to either FICA or self-employment tax. The message went out to all IRS examiners and appeals officers the week preceding the conference informing them of the national office's decision.
How did all of this originate?
The IRS issued two revenue rulings in 1970 which seemingly set the precedent.
Revenue Ruling 70-337 held that bonuses paid by manufacturers to dealership salespeople were not wages for federal employment tax purposes. The critical factor in the ruling was that the payments were for services performed for the manufacturer rather than for the dealer.
The facts in Revenue Ruling 70-337 involve a manufacturer who paid bonuses to salespeople employed by a dealer. The salespersons were paid a bonus by the manufacturer for selling the company's products once sales reached a certain volume. The manufacturer paid no other money to the salespersons and the manufacturer did not exercise any control over the salespersons. The salespersons were hired and otherwise paid by the dealer, and were the dealer's employees under common law rules. The manufacturer sometimes sent the bonuses directly to the salespeople and at other times authorized the dealer to pay the bonuses and subsequently reimbursed the dealer.
Revenue Ruling 70-331 held similarly as to prize points awarded by a distributor to salespeople employed by independent dealers.
Thus, based on these two rulings, dealers with similar facts were not required to withhold or pay other payroll taxes on manufacturer incentive or award payments to their salespeople.
A change in the long-standing position on incentive payments?
In 1994 the IRS issued Technical Advice Memorandum (TAM) 9423004 addressing whether incentive payments made by an automobile manufacturer to a salesman employed by an automobile dealership are subject to self-employment taxes. The Service concluded that the incentive payments were not subject to self-employment taxes. However, they went on to say that, depending upon the facts and circumstances, they may support a finding that a third party payment is an integral part of a dealer's wage structure. Thus, the incentive payments may be wages for federal employment tax purposes and the dealership would be responsible for withholdings and other payroll taxes.
In 1995, the Service issued another technical advice, TAM 9525003, in which they ruled that incentive payments made by an automobile manufacturer to a salesperson employed by an authorized dealership are subject to FICA tax.
In 1996, the Service issued still another ruling on incentive payments, TAM 9647003, with one twist. This ruling again held that payments paid by the manufacturer directly to the salespersons were wages. However, since the manufacturer had control of the payment of such wages, the manufacturer was the employer for all federal employment taxes with respect to such payments. It should be noted that the 1996 ruling did not involve the auto industry.
Conflicting Rulings?
A revenue ruling is very different from a technical advice memorandum. Any taxpayer can use a revenue ruling as authority. Conversely, a technical advice is a ruling given to a specific taxpayer based on their particular facts. However, where similar facts are involved, the IRS may come to a similar conclusion by applying the same law and rationale.
The internal revenue laws generally place the responsibility for withholding and paying employment taxes on employers. However, an initial requirement is that there must be an employer-employee relationship for an employment tax liability to exist. In these rulings, the Service had a wage payment. It was just a matter of attaching an employer-employee relationship to the wage payment.
In response to these conflicting rulings, the IRS' Motor Vehicle ISP (the IRS's national industry specialization program directed at automobile dealerships), issued a September 1995 paper entitled "Bonuses From Man-ufacturers." This announced that the IRS would whipsaw either the dealership, as the common law employer, or the manufacturer or distributor, as the party who initiated the payment, as liable for federal employment taxes on the bonuses. In other words, heads we win, tails you lose. The IRS was going to get their money from someone.
What does this
announcement mean?
The news is good for dealers. There are no employment taxes for the dealer or the manufacturer (or distributor) for all situations factually similar to Revenue Ruling 70-337. The IRS will be retracting their position in TAM 9525003. Further, they will let stand the position in TAM 9423004 that the incentive payments are not subject to self-employment tax.
The manufacturer should issue a Form 1099 to the salesperson. The salesperson should report the income as miscellaneous income subject to income tax, but not self-employment tax. The salesperson should not report the income as business income on Schedule C. The salesperson may deduct any unreimbursed business expenses on Schedule A (subject to the 2% AGI limitation). Salespersons with incorrectly filed tax returns in prior years can amend their returns.
One final word of caution!
Could a dealer still wind up liable for employment taxes? The answer is yes! TAM 9423004 establishes certain situations not covered under Revenue Ruling 70-337. Where a manufacturer's payment is compensation for services performed for the dealership, Rev. Rule. 70-337 will not protect the dealer "if any of the following circumstances is present:
1) the bonuses are an integral part of the wage structure of the dealer-employer,
2) the dealer-employer is liable for payment of commissions to sales personnel even if the manufacturer does not remit the amounts to the dealer, and
3) the dealer-employer indicates to the employee that the compensation will be received by the employee as a result of services the employee performs for the employer."
In summary, there may be a sufficient connection to conclude that the payments are part of an overall compensation package provided by the dealership.
The result of all of this is the dealer's potential liability for additional employment taxes to the tune of at least the 2.9% Medicare portion of FICA, 31% backup withholding, penalties, and interest. The other 12.4% OASDI portion of FICA, FUTA, and state employment taxes may also apply. Section 530 relief (Revenue Act of 1978) does not apply since this issue does not pertain to an employee versus independent contractor determination.
What if the dealership has paid employment taxes on these payments in the past?
There may be an opportunity for the dealership to request a refund of the employment taxes that they paid related to incentive payments.
Alan Strange is with Crowe, Chizek and Company, LLP, a member firm of Auto Team America. If you have specific questions or require more information about this subject, please check the appropriate box on the reader response form on page 3. astrange@dealeronline.com