The IRS sent an Automotive Alert to auto dealers on the taxability of payments made to dealerships under the cash for clunkers (Car Allowance Rebate System (CARS)) program:

The CARS Act specifically states that the credit is not income to the purchaser. The Act does not address the taxability of the credit amount to the dealership or the deductibility of any expenses incurred by the dealership in participating in the program. …

In a typical dealership transaction, a customer may pay for the vehicle in cash, finance the full vehicle price, or finance something less than the full selling price after the application of a cash down payment or a trade-in vehicle allowance. A dealership’s gross receipts include the full selling price of the vehicle, regardless of the form of the customer’s payment. In addition, to the extent the dealership receives any scrap value for the customer’s trade-in, that scrap amount is includible in the dealership’s income.

The credit and ultimate payment by NHTSA to the dealership under the CARS Program is includible in the dealership’s gross receipts from the sale of the vehicle. The dealership must include this income in the year the vehicle is sold.

The dealership is allowed to offset gross income by the cost of goods sold. If the dealership incurs any ordinary and necessary expenses in disposing of the trade-in vehicle an additional deduction may be allowable.