Tax Controversy Update for Week of 11/3/97
Auto Dealership Insurance Agencies; Whose Income; Whose Deductions
In Berger Chevrolet, Inc. v. Commissioner, T.C. Memo. 1997-499 (11/6/97), the Court dealt with a common automobile dealership fact pattern. In furtherance of the dealerships' sales of automobiles, its employees assisted buyers in arranging financing with third party entities and credit life insurance with respect to the financing. Because of state law constraints (encountered in most states), the dealerships could not act as insurance agencies. The owners of the dealerships therefore commonly establish a separate corporate to act insurance agent and earn the insurance commissions. Since the dealerships' employees do all the work, the insurance agency commonly performs only accounting services to account for the insurance commissions to which it is entitled. In Berger, Judge Raum refers to the agency as mere "shadow entities." The dealerships paid its employees additional compensation or "commissions" for insurance that participated in selling. The question in the case was whether that additional compensation or commissions was deductible to the dealerships. The taxpayer urged that they were; the IRS urged that they were not. The additional compensation or commissions were, of course, actually paid by the dealerships. However, the IRS urged that they were really expenses related to the production of income by the separate insurance agencies and therefore were not ordinary and necessary expenses of the dealerships. The Court held for the taxpayer, reasoning that the dealerships' need to provide the full services to its customers in order to sell cars required that its employees undertake these activities and compensating them for doing so was required to stay competitive; hence, the Court reasoned, they were ordinary and necessary. In reaching this holding, the Court questioned why the IRS did not urge that the insurance commission income diverted to the insurance agencies was the income of the dealerships rather than the agencies, thus matching in the same entity the income and related expenses of producing the income. Matching income and related expenses in the same person or entity is, of course, a strong imperative in the tax law. The Court noted that the IRS chose not to make that argument, perhaps because the IRS felt Commissioner v. First Security Bank, 405 U.S. 394 (1972) foreclosed the argument. Yet, if indeed First Security Bank forecloses the allocation of the insurance commissions earned by the insurance agencies to the dealerships, then it would seemingly logically follow that the payments to the dealerships employees were the expenses of the agencies and not the dealerships. We would expect that the IRS will appeal this case.