Vehicle Service Contract (VSC) Price Deposited in Escrow
Account-Recognition of Investment Income of Escrow
Account-Amortization of Premiums Paid for VSC's.-Where
in 1989-91 petitioners were shareholders in four accrual basis
motor vehicle dealerships that sold vehicles with multiyear VSC's
administered by unrelated party, X, under common program;
dealerships retained as profit and currently included in income only
portion of VSC price, while rest of VSC price went to X for (1)
deposit into escrow to fund prospective obligations and (2) payment
of X's fees and premium for excess loss insurance bought from unre-
lated company; dealerships reported escrowed amounts as income
only when released to them; escrow trustees filed Forms 1041 (U.S.
Fiduciary Income Tax Return) treating escrow account investment
income as if escrow accounts were complex trusts; and Commis-
sioner determined dealerships' accounting method for VSC's did not
clearly reflect income because it omitted some items of income and
prematurely deducted some expenses, Court determined dealerships
were required to include escrowed VSC funds in income in year of
sale, since arrangement was properly treated as sale (Commissioner
v. Hansen, 360 U.S. 446, followed) and did not constitute purchaser
deposit (Commissioner v. Indianapolis Power & Light Co., 493 U.S.
203, distinguished) or trust fund for benefit of purchaser (Angelus
Funeral Home v. Commissioner, 47 T.C. 391, and Miele v. Commis-
sioner, 72 T.C. 284, distinguished); under secs. 671 and 677, dealer-
ships were treated as owners of escrow accounts and required to
include investment income in gross income currently; and pre-
miums for excess loss insurance had to be capitalized and recovered
through amortization, while administrators' fees for escrow
accounts were deductible according to refund formula that would
reasonably measure administrators' performance of services over
life of VSC's; and under sec. 481 Commissioner was authorized to
adjust one petitioner's income for its 1990 taxable year to reflect
aggregate of unreported income realized from sale of VSC's in prior
years plus accumulated investment income reduced by various
allowable deductions and amortization allowance for premiums.
Johnson v. Commissioner