Demonstrator Vehicles Going the Way of the Dinosaurs
by Kim Virkler
Auto Dealer Alert, 2007 Volume 5

Scientists tell us that several million years ago dinosaurs disappeared from the face of the earth because of severe climate changes that affected them. In today’s economic environment, there are significant pressures and changes that are impacting the practice of allowing employees the use of demonstrator vehicles. The factors that are putting pressure on providing demonstrator vehicles for employee’s personal use can be summarized as follows:

Legal: At the NADA convention this year, there were presentations given that included the risks dealerships incur by employees having personal use of demonstrators. The legal concerns include accidents that have occurred involving a demonstrator when the driver was not an employee of the dealership (i.e., spouse, child, or friend of the employee).

There have been unfortunate cases when the employee driving the demonstrator has been in an accident while driving under the influence. The situation becomes a bigger problem when the employee had a record of DUI. The obvious question is why the dealership would allow an employee who had a DUI record to have a demonstrator vehicle. Special attention should be focused on the driving record of each employee that has a demonstrator.

Since the dealership is the owner of the vehicle and has perceived “deep pockets,” an accident involving a
company-owned demonstrator can be a law suit waiting to happen.

Federal Tax: The IRS has always targeted demonstrators as an area to look at when they audit a dealership. The reason is that the IRS believes that any non-salesperson that has a demonstrator vehicle is receiving a form of compensation, and the IRS wants to tax the benefit. The NADA and IRS have agreed to this. The IRS will not chase the individual for the tax, but rather will assess the dealership for the withholding tax, Medicare tax, and Social Security tax if applicable. If a dealership is audited, the IRS-determined value of the demonstrator that is used by a non-salesperson will be subject to the federal tax withholding (28 percent), Medicare (2.9 percent) and Social Security employer and employee portion (12.4 percent), plus penalty and interest for all such demo use for the past three years. It will be a big number.

State Tax: Historically, the state of Michigan allowed (for most dealerships) 25 free vehicle-specific, plated demonstrators per year. Once the 25 vehicle exemption for new and used vehicles had been exceeded, a use tax was required to be paid to the state each month based upon the value of the vehicle.

On May 25, 2007, the Michigan Supreme Court ruled in the Betten Auto Center v. Michigan Department of Treasury case that vehicles purchased by a dealership held in inventory for resale, used by the dealership’s employees, and ultimately resold, were no longer subject to the use tax provisions. The state of Michigan has filed for a motion for reconsideration of the Supreme Court’s ruling, but it appears dealers who have paid use tax on demonstrators in the past would be eligible for refunds on returns filed within the past four years (Michigan statute of limitations period). These refunds are obtained through the filing of amended use tax returns, and we recommend dealers not delay in filing these amended returns in order to prevent the statute of limitations from expiring on earlier returns.

Cost of Demonstrators: There is a substantial cost to a dealership to provide demonstrator vehicles. The cost includes: depreciation cost of the decline in value of the vehicle; floor plan interest cost of carrying the demonstrator in inventory; insurance premium to insure the vehicle; insurance deductible if the vehicle is involved in an accident; fuel, maintenance, and cost of necessary repairs. If you add these amounts together, along with any federal or state taxes that may be due, it will be a big number – which is hard to accept in these difficult economic times. This, along with the legal liability exposure, makes it difficult to justify demonstrator vehicles for personal use. A one-time raise for employees to buy or lease a vehicle in their own name may be an ultimate cost savings to a dealership.

Conclusion: Dinosaurs didn’t survive, and the question is, will personal use of demonstrator vehicles survive? Can you afford, or should you continue, to provide demonstrators for your employees?