The IRS’ 2013 release of its tangible property regulations clarified the proper tax treatment of expenditures related to tangible property, including buildings. Specifically, they explained how to distinguish between immediately deductible business expenses and capital expenditures that you must recover over time through depreciation.
The final rules included a “de minimis” safe harbor that allows taxpayers to avoid capitalization of certain expenditures, thereby reducing their current-year taxable income. But the safe harbor imposed some restrictions that limited its value for many taxpayers. Now the IRS has amended it in a way that should allow more small businesses to immediately deduct more costs. The change takes effect for the 2016 tax year.
The de minimis safe harbor allows taxpayers with an “applicable financial statement” (generally, a certified audited financial statement) to elect to deduct all amounts properly expensed up to $5,000 per invoice or item. But the regulation limited smaller taxpayers who don’t typically have audited financial statements to a much smaller deduction.
These taxpayers could apply the de minimis safe harbor only if the amount paid didn’t exceed $500 per invoice or item. In addition, it required them to have a written accounting policy and procedures in place for expensing amounts paid for property costing less than a certain dollar amount or for property with an economic useful life of 12 months or less.
If the cost exceeded that threshold or the taxpayer didn’t have the written policy and procedures in place, no portion of it fell within the safe harbor. You either had to capitalize the expense or elect the Section 179 deduction and risk recapture of some of the expensed amounts down the road.
The IRS has increased the threshold for taxpayers without an applicable financial statement to $2,500. (The limit for taxpayers with applicable financial statements remains at $5,000.) To take advantage of the safe harbor, you must have the accounting policy and procedures described above in place at the beginning of the tax year for which you are making the election.
The IRS has also pledged to provide audit protection on the issue. That means the agency won’t challenge your use of the higher threshold in tax years beginning in 2012, 2013, 2014 or 2015 if you otherwise satisfied the requirements. If you didn’t have the required policy, for example, you’re stuck with the $500 threshold.
You must consistently comply with the expensing policy in your books and records. For example, if you have a policy requiring the expensing of amounts paid for invoices or items below $2,500, you need to expense every such invoice or item. You aren’t allowed to expense some but capitalize others.
Moreover, the safe harbor applies only to amounts that don’t exceed the $2,500 threshold, regardless of where you set the threshold in your accounting policy. The policy might require the expensing of amounts paid for invoices or items below a higher threshold — but the safe harbor will still apply only to invoices or items that don’t exceed $2,500.
Under the recent changes, your expensing policy is required to be in writing only if you have an applicable financial statement. Nonetheless, it may be advisable to have a written policy and procedures in case you ever attract the IRS’s attention. It could help you make the case that you were entitled to make the safe harbor election.
If you want to put the new threshold to work for you, you must make an annual irrevocable election. Then you must apply it to all amounts paid in the taxable year for tangible property that satisfies the requirements.
For more information or discussion, contact Patrick Walsh.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this publication should be taken only after a detailed review of the specific facts and circumstances.