Parties involved in auto warranties / service contract
Administrator as a entity, other than the provider of the service contract or an employee of the provider, who is responsible for the third-party administration of a service contract. Third party administration of a service contract includes any of the following activities performed on behalf of a service contract provider:
- performing or arranging the collection, maintenance, or disbursement of money to compensate any party for claims or repairs pursuant to a service contract;
- participating in the processing or adjustment of claims arising under a service contract;
- maintaining records required by states; or
- comply with provider requirements, other than financial security requirements
The term does not include the performance of repairs, or clerical functions ancillary to the performance of repairs, by a repair facility that performs no other activities with respect to a service contract.
Service Contract Provider provides extended warranties to consumers for a specified period of time and for an additional cost beyond the price of the product.
Seller/Agent/Producer. For instance a retailer may sell a consumer a service contract in which another party, such as the manufacturer of the product, is obligated to pay any claims made against the contract. If the extended service contract is between the vehicle purchaser and an administrator, insurance company or other party, the dealership acts as an agent and earns a commission.
Generally, the dealership determines the selling price of the extended service contract and forwards a portion to the administrator based on a "cost schedule." The commission income must be accrued when the contract is sold. The commission amount is the difference between the extended service contract selling price and the amount the dealer forwards to the administrator, insurance company, or other party.
Service contract means a contract or agreement, for a separate or additional consideration, for a specific duration to perform the repair, replacement or maintenance of property, or indemnification for repair, replacement or maintenance, due to a defect in materials or workmanship or wear and tear, with or without additional provision for indemnity payments for incidental damages, provided any such indemnity payment per incident shall not exceed the purchase price of the property serviced. Service contracts may include towing, rental and emergency road service, and may also provide for the repair, replacement or maintenance of property for damage resulting from power surges and accidental damage from handling. Service contracts may also include contracts to repair, replace or maintain residential appliances and systems. (emphasis added)
Service Warranty Income Method (SWIM): - An election under Revenue Procedure 97-38, previously 92-98, which provides for an alternative Income reporting method, the "Service Warranty Income Method" (SWIM). Taxpayers who elect SWIM may spread a portion of the service warranty contract income over the life of the contract. The amount of income that can be deferred is equal to the amount that is paid by the taxpayer to an unrelated third party to insure the taxpayer's obligations under their contracts. The amount qualifying for deferral is called the "Qualified Advance Payment Amount." The SWIM method only applies when insurance is purchased from an unrelated party.
Service Contract Overpayment Programs: - Also known as Dealer over-submit, Dealer Override, Dealer Remit or Management Programs. This is a supplemental program that may be included in the vehicle service contract. This calls for a voluntary supplemental agreement to pay an administrator a fee in addition of the contractually required amount.
Agent versus Principal/Obligor
A dealer can market after-sale products as either an agent or as a principal. Dealers sometimes attempt to structure these transactions so they will be classified as agents due to the favorable tax treatment.
What an agent or principal/obligor is in the context of the sale of extended service contracts can be loosely defined as follows:
An agent is one who sells the products of a third party insurer without assuming the legal obligations or insurance risk of the product sold. The agent receives a fee for the sale and necessary administrative services rendered. The activities of an agent are not strictly limited to sales of insurance. In the past, some dealerships were selling factory extended "warranties" as agents for a product that was not then considered by the parties to be an "insurance" product.
A principal is a party to the contract who assumes the risk in the contract, is directly responsible for any ensuing liabilities that may arise and derives compensation from the profit built into the product sold. The principal in the automobile context will generally insure the obligations undertaken in these contracts with a third party insurer, but remains the primary obligor to the consumer.
As a principal/obligor, dealers should include in income the full amount received from the consumer for the mechanical breakdown contract. The amount remitted for the insurance premium should then be amortized over the term of the contract.
Many service contracts are handled by companies called administrators, that authorize the payment of claims to any dealers under the contract. If you have a dispute over whether a claim should be paid, deal with the administrator.
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