The final tangible property regulations issued in 2013 provide a safe harbor election that allows qualifying businesses to immediately deduct purchases of tangible property below certain dollar thresholds. For taxpayers that do not have an applicable financial statement (typically an audited financial statement) (“AFS”), the dollar threshold was $500.The IRS received many comments suggesting that the $500 threshold was too low to effectively reduce the administrative burden of complying with the capitalization requirement for small businesses. After consideration of these comments, the IRS recently announced that the de minimis safe harbor threshold would be increased to $2,500 beginning with 2016 tax years. The dollar threshold for taxpayers with an AFS remains at $5,000.
The final tangible property regulations issued in September, 2013, introduced the de minimis safe harbor election, applicable to taxable years beginning on or after January 1, 2014. The de minimis safe harbor is an annual tax return election that permits taxpayers to currently deduct expenditures they would otherwise have to capitalize for the purchase of tangible property (including materials and supplies) if the taxpayer:
- Has an accounting policy as of the beginning of the tax year to expense (for non-tax purposes) amounts paid for property costing less than a specified dollar amount, or amounts paid for property with an economic useful life of 12 months or less, and
- Follows that policy in its books and records.
For taxpayers with an AFS, typically an audited financial statement, the specified dollar threshold for the de minimis safe harbor is $5,000 per invoice or item. Additionally, the taxpayer’s accounting policy must be in writing.
For taxpayers without an AFS, the specified dollar threshold was only $500 per invoice or item. Also, although the taxpayer must have a capitalization policy, the policy need not be in writing.
If a taxpayer’s accounting policy is less than the $5,000/$500 thresholds, the amount deductible under the de minimis safe harbor is limited to the threshold set by the policy. Conversely, if a taxpayer’s accounting policy is more than the $5,000/$500 thresholds, only expenditures up to the $5,000/$500 thresholds are protected under the de minimis safe harbor. Note, however, that the de minimis safe harbor does not limit a taxpayer’s ability to deduct otherwise deductible repair or maintenance costs that exceed the safe harbor threshold. The safe harbor merely establishes a minimum threshold below which all qualifying amounts are considered deductible.
For taxpayers subject to the uniform capitalization rules for the production or acquisition of inventory, amounts paid for tangible property below the de minimis safe harbor threshold may still need to be capitalized if those amounts comprise the direct or allocable indirect costs of property produced or acquired for resale.
A taxpayer makes a de minimis safe harbor election annually by attaching a statement to its timely filed original federal tax return (including extensions).
Threshold Increased for Taxpayers without an AFS
Notice 2015-82, issued on November 24, 2015, increases from $500 to $2,500 the de minimis safe harbor threshold for taxpayers without an AFS. The threshold increase is effective for taxable years beginning on or after January 1, 2016.
The IRS also announced that for tax years prior to 2016, it would not raise upon examination the issue of whether a taxpayer without an AFS can use the $2,500 de minimis safe harbor threshold if it otherwise satisfies the de minimis safe harbor requirements. Because one of the de minimis safe harbor requirements is that the accounting policy to expense amounts below a certain threshold must be in place as of the beginning of the tax year, taxpayers without an AFS generally will still be limited to the $500 threshold for 2015 unless their pre-existing capitalization policies already exceeded $500.
The increase to $2,500 in the de minimis safe harbor for taxpayers without an AFS is welcome relief that should simplify recordkeeping and generate more current tax deductions. Many more assets that traditionally were capitalized, such as many computers, tablets, smartphones, and high-end office furniture, now potentially can be deducted immediately.
Keep in mind the following points as you contemplate this change for 2016:
- If you expect to provide financial statements to any third parties, such as banks or investors, consider the impact of any increase to your capitalization policy on your financial statements. You may decide that the $2,500 threshold is too high for your situation.
- Because the amount that can be deducted under the de minimis safe harbor is limited to the lesser of the threshold (now $2,500 for taxpayers without an AFS) or the taxpayer’s accounting policy, we recommend that you document your accounting capitalization policy (or any changes to it) prior to January 1, 2016 (even though a written policy is not required for taxpayers without an AFS).
- To apply the de minimis safe harbor, you must follow the accounting policy for non-tax purposes, i.e., for your books and records. If you choose to take full advantage of the increased safe harbor threshold for 2016, make sure you are expensing all tangible property purchases below $2,500.
- The de minimis threshold is applied per invoice or per item. If you frequently purchase multiple pieces of the same equipment at one time (e.g., computers, tablets, etc.) and you want to maximize your current deductions, make sure that your accounting staff is applying the de minimis threshold on a per item basis.
- To the extent that tangible property below the de minimis threshold is used in the production or acquisition of inventory, those expenditures may need to be capitalized into the cost of the inventory if you are subject to the uniform capitalization rules.
- The de minimis safe harbor election is an annual election that must be made on each year’s timely filed federal tax return (including extensions). The increase in the threshold makes it even more critical to ensure that the election is made properly and that the tax return is timely filed.
Bob Smith is a Director in the Tax Group at CBIZ Tofias. He can be reached at 617.761.0705 or RSmith@cbiztofias.com.