In 2014, new treasury regulations created a de minimis safe harbor rule for capitalizing assets. These rules were intended to clarify for taxpayers whether certain types of expenditures should be expensed or capitalized. More recently, with IRS Notice 2015-82, the Internal Revenue Service (IRS) updated the de minimis safe harbor threshold from $500 to $2,500 for taxpayers without an applicable financial statement (AFS). The increase is in effect for tax years beginning January 1, 2016, or later, but the notice states that the IRS wouldn’t raise the issue on audit for a taxpayer using an amount that is more than $500 but not exceeding the $2,500 limit prior to 2016 if the taxpayer meets all the other requirements for the proper application of the rule.
This change resulted from numerous comments the IRS received from concerned taxpayers and practitioners regarding the disparity in treatment between those with an AFS and those without. The notice also reminds taxpayers that the de minimis rule doesn’t prevent a taxpayer from properly deducting as repairs larger amounts that qualify as repairs and maintenance.
According to Treasury Regulation §1.263(a)-1(f)(1)(ii), a taxpayer without an AFS must have written accounting procedures in place at the beginning of the tax year to treat items that cost less than a specified amount or have an economic useful life of not more than 12 months as an expense for nontax (book/financial) purposes. The taxpayer must also follow this policy for book purposes. Yet the IRS FAQ page related to this topic (1.usa.gov/1YwVx4I) states that those taxpayers without an AFS aren’t required to meet the written procedure requirement but must still expense these items for book purposes to take advantage of this rule. It’s important to remember, however, that the FAQ page isn’t authoritative like the notice and regulations.
The regulation itself includes the $500 amount per invoice as the dollar limitation, but it provides room for the amount to be changed as identified by later guidance published in the Federal Register or in the Internal Revenue Bulletin—which has now been done in Notice 2015-82. As a result, the maximum de minimis amount for those without an AFS is now $2,500.
Other rules related to the safe harbor remain unchanged. Those with an AFS are still allowed to use the policy for amounts up to $5,000. In determining if a taxpayer has an AFS, the applicable financial statements are, in order of priority: (1) a financial statement filed with the U.S. Securities & Exchange Commission (SEC), (2) a certified audited financial statement, with an independent CPA’s report, that’s used for either credit purposes or reporting to owners or for some other substantial nontax purpose, and (3) a financial statement (which can’t be a tax return) that’s required to be filed with the federal or state government or one of their agencies.
Similarly, the rule requiring consistency of all qualifying amounts remains if the safe harbor election is made. This means that all amounts that qualify under the rule must be expensed if the de minimis option is elected. The election is made by attaching a statement to a return (including extensions) that’s filed in a timely manner. Once made, the election is irrevocable. (See the Taxes column in the February 2014 Strategic Finance for a more detailed look at the original de minimis rule.)
The following example, adapted and modified from the regulations, clarifies the impact of the change. Assume that XYZ Co., a professional services company that doesn’t prepare an AFS, decides to replace its old office furniture with new ergonomic desks. XYZ purchased 150 desks for $1,600 each for an invoice total of $240,000. Under the previous application of the regulation, the company wouldn’t be able to claim an immediate deduction for these amounts since the invoice amount of $1,600 per desk exceeds the $500 maximum originally allowed. As a result, XYZ would only be able to immediately expense the items if another provision, such as IRC §179, were applicable to the assets acquired.
The increase in the de minimis limit thus provides XYZ with three benefits:
- A deduction of the full $240,000 in the year the desks are placed in service is applicable, rather than a deduction of $34,296 that year and the balance deducted over the next seven years per MACRS (assuming no §179 or bonus depreciation).
- It will be unnecessary to create new fixed asset subsidiary ledgers, to uniquely identify each desk, or to create a pooled asset account for the desks.
- The expensed desks won’t count as part of the new assets placed in service limit for §179 purposes if XYZ otherwise qualifies for §179 and is facing this limitation.
The IRS also has made another improvement to the filing requirements related to 2014 in Revenue Procedure 2015-20. When a taxpayer makes changes to how these items are accounted for, the regulations normally require the taxpayer to report a §481 adjustment reflecting the accumulated effect of the new vs. the old method of accounting for the item. Rev. Proc. 2015-20 allows small taxpayers to use the cut-off method for accounting for this change and thus avoid the filing of Form 3115 for the 2014 year. Under the simplification, these taxpayers are required to reflect only the amounts paid or incurred and dispositions that occurred in tax years beginning on or after January 1, 2014. In order to qualify as a small taxpayer for this purpose, the taxpayer must have total assets of less than $10 million as of the first day of the tax year for which the change in method is effective or have average annual gross receipts of $10 million or less for the prior three tax years. This allowance typically won’t result in a tax savings, but it does avoid the administrative burden of dealing with the §481 adjustment.
Since taxpayers making the change would typically do so in order to take advantage of immediate deductions rather than capitalizing items, the adjustment would normally free up costs that had been capitalized in earlier years and that should have been expensed under the new method. The resulting negative adjustment results in a current-year tax savings. Under the cut-off method, amounts that had been capitalized in years prior to the change would remain trapped.
These changes should help taxpayers. The change allowing up to $2,500 to be expensed under the capitalization regulations, in particular, will certainly be welcomed by taxpayers who found the $500 amount insufficient.
Anthony P. Curatola is editor of the Taxes column for Strategic Finance, the Joseph F. Ford Professor of Accounting at Drexel University in Philadelphia, Pa., and a member of IMA’s Greater Philadelphia Chapter. You can reach Tony at (215) 895-1453 or curatola@drexel.edu.
© 2016 A.P. Curatola
May 2016
