Taxation of VW Settlement Payments: Don’t Expect Any Advance IRS Guidance

 In Will's blog

On February 14, I participated in a follow-up conference call / discussion hosted by Paul Metrey of NADA (Vice President, Regulatory Affairs) involving several CPA firms whose input NADA sought on whether it would be advisable at this time to seek guidance from the IRS on the interpretation of several key income tax issues arising from the payment of settlement awards by Volkswagen to Volkswagen dealers.

Prior to the “fairness hearing” on January 23, NADA had made the decision to wait to see if any changes were made to the settlement terms … and none were made.

As a result of the conference call and other input, NADA has made the decision to not seek guidance from the IRS on any of the tax issues involved. This was also the recommendation by a VW dealership group.

The almost unanimous conclusions from the CPAs involved in the conference call were that (1) guidance should not be sought from the IRS and (2) that payments received for reduction of the VW franchise goodwill would be, or could be, offset against any basis previously capitalized in connection with the VW franchise.

Accordingly, CPAs will have to reach conclusions on their own as to how much to accrue initially, whether payments are ordinary income, whether long-term capital gain or Section 1231 treatment may be involved, whether Section 1253 comes into play, whether Section 197 is operative, whether installment treatment under Section 453 is a possibility … not to mention the potential for the IRS to invoke the penalty provisions of Sections 6662–6664 if it does not agree with what it finds (if it finds it) in the tax returns when they are filed in just a few months from now.

The take-away from all of this is obvious … It seems that most CPAs are willing to wait in the weeds and see what happens to somebody else. Although many dealers will receive millions of dollars, the tax revenue arising from these amounts is a drop in the bucket compared to many of the other issues that the IRS might want to take on.

As a CPA, at this point, how comfortable are you with all of this?

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  • lawrence e stirtz

    I would concur on not asking for clarification. Looking at the authorities at this point I feel there is enough to claim 1231 treatment. 1253 needs some attention but do not think it is a big issue. Of on a C corp it makes not difference. I have been under the impression that installment treatment will be available but will do another look. Finally I think there is enough support for a disclosure that will protect those positions. Maybe we should collaborate on one rather than each invent the wheel. Thanks

  • Joseph Magyar

    I am responding to the question raised on this blog, “As a CPA, how comfortable are you with this?”

    Because Crowe Horwath LLP has dozens of VW dealers among our hundreds of dealer clients, we have looked at the VW class action settlement very thoroughly and carefully. We have also been in discussions with many other CPA firms and various IRS contacts. Additionally, we reviewed the many VW class action lawsuit documents on the District Court’s website and conferred with the attorneys that represented the dealers in this matter. We were involved in several conference calls with NADA, attended the “Fairness Hearing” in San Francisco and assisted in the preparation of the information piece that NADA distributed to the VW dealers.

    For our internal purposes, we prepared a white paper research document which we believe fairly and completely presents and discusses the relevant facts, law and conclusions. We considered the opinions of other professionals when we prepared our document. We believe that the arguments in the document provide significant support for the conclusions. We are quite confident that we have determined the proper treatment for almost all of the situations that our VW clients will present to us. We have followed the pattern generally applied in determining the proper tax treatment for lawsuit settlements by examining, very closely, the factors surrounding the origin of the claim including considering the pleadings submitted to the court and the settlement approved by the court.

    If we are so confident in our position, why not then seek guidance from the IRS? It is not that we fear that guidance that the IRS would provide would be radically different than what we have concluded. Rather, there are other considerations that cause us to agree with the decision not to seek guidance from the IRS at this time. Here are some of the factors we considered:

    What kind of advice should be sought?
    o Private letter ruling (PLR) – There are at least eight different scenarios that the VW dealers could have depending on whether they had purchased goodwill, amortized it partially or completely, amortization recapture, pure capital gain, etc. Since a PLR is limited to the facts of one particular dealer, multiple PLRs would be needed to address the various situations.
    o Industry Issue Resolution (IIR) – Dealers have benefitted several times though the IIR and other collaborative IRS processes e.g. Alternative LIFO, Demos, LIFO Pooling, UNICAP, etc. However, there is a risk that the IRS could include a “rough justice” element that could make an IIR result less than ideal.

    o How quickly would the IRS issue the guidance? In time to file returns without extending them? Probably not.
    o If the guidance was slightly different than the return position would amended returns become necessary?
    o Would the guidance encompass all of the many varied situations that our VW clients may encounter?
    o Even if guidance is not pursued at this time, it is possible that guidance could be sought at a later time if the IRS raised significant issues during audits. This, in fact, is when guidance has been requested for almost all of the previous issues.

    o Our past experience has been that seeking IRS guidance is a costly process. The guidance process starts with a submission that is inclusive, well written, fully documented and comprehensive. This requires significant resources. Generally, at least one, if not more, conferences are held in Washington, DC to discuss the issues. Frequently, additional submissions are required to respond properly to IRS questions.
    o It is possible that, based on our recent contacts with decision makers within the IRS, there is consensus that the return position of the dealers is proper and should not be challenged.

    VW dealers’ input
    o Most dealers are satisfied with the tax treatment that has been explained to them by their CPAs.
    o Generally, they see little reason to go for guidance at this time.

    For all of these reasons, my colleagues and I at Crowe Horwath LLP are very comfortable with the decision by NADA and support this decision as being in the best interest and desires of the VW dealers. This appeared to be supported by a broad consensus of half a dozen other CPAs that participated in the conference calls with NADA personnel.

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