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IRS rules on extended warranties.

The IRS recently issued its long-awaited rule setting forth a method for income recognition by automobile dealers on the sale of extended warranty contracts to the purchasers of automobiles. Under this method, the entire amount received from sales of extended warranties would not have to be reported as income in the year of receipt, which would avoid a cash flow problem for the dealer. This same method would also be used by dealers in other durable goods.

To take advantage of this method, the dealer must meet specific requirements. The extended warranty contract must qualify as a true service arrangement separately priced by the dealer. In addition, the dealer must purchase true insurance to protect against the risk of having to provide the required service. If all of the requirements are met, the income to be reported by the dealer in the year of the sale of the contract is - the excess of the contract price received over the amount of the insurance premium paid, and - a pro rata portion of the amount paid for insurance increased by an imputed income amount.

This method of accounting allows dealers to recognize in income, generally over the period of the warranty contract, a series of equal payments, the present value of which equals the amount received in the year the contract is written.

The new method is effective for tax years beginning on or after June 12, 1992. The Service has also issued a procedure to automatically change the method of accounting for the treatment of the deduction for the purchased insurance; dealers must deduct the amounts paid to insurers ratably over the term of the insurance coverage.
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Author:Devlin, Frank C., Jr.
Publication:The Tax Adviser
Article Type:Brief Article
Date:Mar 1, 1993
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