Simplify, Simplify, Simplify
Increase in the De Minimis Safe Harbor for Tangible Property
If your business regularly purchases items such as computers, other small equipment or mobile devices, you’ll be pleased to learn that accounting for these transactions may now be easier. IRS Notice 2015-82, issued late in 2015, increased the de minimis safe harbor for deducting (rather than capitalizing) the amounts paid to acquire, produce or improve tangible property from $500 to $2,500 per item for small businesses that don’t have “applicable financial statements.”
Explaining the Benefits
The safe harbor simplifies the accounting and gets rid of the requirement to choose whether smaller-dollar expenditures should be deducted or capitalized. Before Notice 2015-82, a small business had to have “applicable financial statements” in order to enjoy a safe harbor of more than $500. (See “De Minimis Unchanged for Businesses with Applicable Financial Statements.”) An “applicable financial statement” is typically defined as a financial statement filed with the SEC, or an audited financial statement and CPA report (used to obtain a loan, or provided to shareholders or to another federal or state government agency). Many small businesses don’t have such statements, so Notice 2015-82 may significantly benefit them.
The change is effective for tax years beginning on or after January 1, 2016. What’s more, the IRS has said that it won’t challenge the use of the $2,500 safe harbor for years before 2016, as long as the taxpayer has satisfied all other safe harbor requirements.
The change was created to simplify the recordkeeping required to maintain compliance with the capitalization rules. The previous safe harbor limit of $500 was so low that many items most businesses regularly would purchase still needed to be capitalized. Thus, it did not do much to simplify the administrative work which many small businesses dealt with in complying with the capitalization requirements.
In order to take advantage of the de minimis safe harbor, the following requirements need to be met:
- The amount deducted must be for ordinary and necessary business expenses, and
- The business is required to expense these amounts on its books according to a consistent accounting procedure or policy that existed at the beginning of the taxable year. It must use the safe harbor for all expenditures that meet the criteria in that taxable year. It can’t pick and choose to expense some and capitalize others.
The safe harbor election does not, however, apply to any purchases of inventory, some spare parts and land. For example, the direct and allocable indirect costs of constructing a new building must be capitalized.
But businesses can take deductible repair and maintenance costs that exceed the $2,500 threshold under the tangible property rules that apply to those types of expenses.
How to Use It
A business electing the safe harbor will need to attach a statement called a “Section 1.263(a)-1(f) de minimis safe harbor election,” to its tax return for the year in which the de minimis amounts were paid. The statement would be expected to include the company’s name, address and taxpayer identification number, and should also note that it is making the safe harbor election.
The election does not constitute a change in a company’s method of accounting, so it will not be necessary to file Form 3115, “Application for Change in Accounting Method.” Nor, will it be necessary to file this form to change the amount deducted under the company’s book policy. It will also not be necessary to file it to stop applying the safe harbor in a subsequent tax year.
For those costs which do not qualify under the safe harbor, the business will still apply the general rules for identifying and deducting costs for repairs and maintenance, as well as for materials and supplies. If a business with no applicable financial statement has previously had a policy of deducting the costs spent to acquire and improve tangible property that exceed $2,500, it can then properly deduct those amounts for federal tax purposes, as long as it can show that its reporting policy clearly reflects its income. But, the IRS does advise, in “Tangible Property Regulations — Frequently Asked Questions”, that the electing of the safe harbor for items costing no more than $2,500 likely will reduce the risk of IRS questions.
How to Simplify
Businesses that don’t have applicable financial statements will want to revisit their policies for capitalizing purchases of tangible property, given the new higher de minimis safe harbor amounts. The businesses which have been capitalizing purchases of less than $2,500 may discover that they can streamline their internal processes and simplify part of their recordkeeping by taking advantage of the new higher safe harbor limit. Your accounting professional will be able to provide more information on the safe harbor and how you might apply it to your business.
Sidebar: De Minimis Unchanged for Businesses with Applicable Financial Statements
The de minimis safe harbor for businesses with applicable financial statements, such as an audited financial statement accompanied by a CPA report, remains at $5,000 per invoice or item. The business needs to treat the amount paid as an expense on its financial statements, in accordance with its written accounting procedures.
The IRS noted that the larger safe harbor is appropriate for these businesses because their audited financial statements provide independent assurance that their de minimis policies are consistent with generally accepted accounting principles, and don’t materially distort the financial statement income.
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