Federal Tax Research 10th Edition by Roby Sawyers,William Raabe,Gerald Whittenburg,Steven Gill

Exercise 4

Bob Carburetor is the new owner of Carburetor Cars, an accrual-based corporate taxpayer. At Carburetor Cars, when a vehicle is sold, the dealership tries to sell an auto service contract. The amounts received for these contracts are placed into an escrow account. The agreements grant the buyers the right to have parts or components covered by the contract repaired or replaced, whenever the covered parts experience a mechanical difficulty. The dealer will either provide the services or reimburse the car buyer for the reasonable cost of repair or replacement. Normally, the buyer returns the vehicle to the dealer for repair, but this is not required. In either case, the repairs or replacements must be authorized in advance by an administrator hired by Carburetor Cars. Fees to the administrator of the contracts are paid out of the escrow account. What is the proper tax treatment for the income from the service contracts When are the payments to the administrator deductible