Sales and Use Tax Audits — Are You Prepared?
by Kurt Beck
Auto Dealer Alert, 2007 Volume 1

In an effort to generate revenue, there’s been a significant increase in audit activity by the state of Michigan over the last several months. Many auto dealers have been audited regarding sales and use tax issues. While most dealers are aware that these audits are occurring, many aren’t aware of the specific areas under scrutiny or, if aware, may not be as diligent in monitoring those areas as they should. This has cost some dealerships tens of thousands of dollars.

So what areas are auditors targeting? To begin, dealerships must be mindful of the “up to 25 demo” rule. Michigan law states that dealerships are allowed up to 25 tax-free demonstrator vehicles per year, depending upon their sales volume of new vehicles. Once they exceed their allotted amount, each successive vehicle does not qualify for the demonstration exemption. While most dealers are aware of this rule, it’s very easy to lose track of how many demo vehicles have been put in use. Thus, when audited, they’re surprised to learn they’ve surpassed their allowance. It’s important to keep track of these vehicles to assure you won’t be caught off guard.

Second, auditors are reviewing used vehicles. If significant miles appear on these vehicles (with the auditor’s threshold typically starting around 500–1,000), the state considers them demos and subject to use tax. This is another area that tends to catch some dealers off guard. In addition, loaner vehicles provided to customers whose cars are being serviced may also be subject to use tax, even if the customer hasn't been charged.

Another significant area pertains to auto parts. In the event that a customer needs to bring their vehicle in for a second repair (presuming the first visit didn’t fix the problem), dealers oftentimes don’t charge their customer for the cost of the necessary auto parts. These parts are still subject to use tax, and auditors will review any policy adjustments to make sure the dealer paid the tax on these parts. Additionally, any items that are consumed by the dealership—for example, a part is taken out of the parts department and placed on a service vehicle—are subject to use tax.

These are the major areas auditors are reviewing, but they’re not the only ones. If you are audited, contact your professional tax advisor.

In 2005, the State of Michigan revealed that they would increase enforcement of failure to file unclaimed property reports. Although to date, we've only seen limited audit activity, there are still indicators that audit activity will increase. Penalties for failure to file are significant. Next month we will address how to report unclaimed property.