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FAQs shed new light on tangible property regs’ de minimis safe harbor election

IRS has issued new frequently asked questions (FAQs) on the final tangible property capitalization regs. The FAQs include new details on the de minimis safe harbor election, a useful and widely applicable break that allows many businesses to dispense with capitalizing and depreciating (or expensing under Code Sec. 179 purchases of many lower-cost assets (e.g., furniture, equipment, computers) needed to run a business.

Background. The final tangible property regs issued in 2013 (T.D. 9636) generally provide that, unless an expense qualifies as a material or supply, a taxpayer must capitalize amounts paid to acquire or produce a unit of property (UOP), whether real or personal property, including leasehold improvement property, land and land improvements, buildings, machinery and equipment, and furniture and fixtures. (Reg. § 1.263(a)-2(d))

As an alternative to the general capitalization rule, the final regs permit businesses to elect to expense their outlays for “de minimis” business expenses. If the taxpayer is eligible for the de minimis safe harbor election, and chooses it, an amount paid to acquire or produce any eligible UOP (or any eligible material or supply) is deducted in the year paid or incurred under Code Sec. 162, and may not be capitalized or treated as a material or supply. However, de minimis amounts paid for tangible property may be subject to capitalization under Code Sec. 263A, if the amounts include the direct or allocable indirect costs of other property you produced or acquired for resale. (Reg. § 1.263(a)-1(f)(1), Reg. § 1.263(a)-1(f)(3)(iv), Reg. § 1.263(a)-1(f)(3)(v))

The de minimis safe harbor applies to an amount paid during the tax year to acquire or produce a UOP, or acquire a material or supply, only if:

A. The taxpayer has at the beginning of the tax year written accounting procedures treating as an expense for non-tax purposes amounts paid for property (1) costing less than a specified dollar amount; or (2) with an economic useful life of 12 months or less;
B. The taxpayer treats the amount paid for the property as an expense on its applicable financial statement (AFS) if it has one – or on its books and records if it does not – in accordance with its accounting procedures; and
C. If the taxpayer has an AFS, the amount paid for the property does not exceed $5,000 per invoice (or per item as substantiated by the invoice), or if the taxpayer does not have an AFS, does not exceed $500 per invoice (or per item as substantiated by the invoice), or other amount as identified in published IRS guidance. (Reg. § 1.263(a)-1(f)(1)(i), Reg. § 1.263(a)-1(f)(1)(ii))

AFS defined. A taxpayer’s AFS is its financial statement listed below that has lowest number:

1. A financial statement required to be filed with the Securities and Exchange Commission (SEC) (10-K or the Annual Statement to Shareholders).
2. A certified audited financial statement accompanied by the report of an independent certified public accountant (or in the case of a foreign entity, by the report of a similarly qualified independent professional) that is used for:
A. Credit purposes;
B. Reporting to shareholders, partners, or similar persons; or
C. Any other substantial non-tax purpose.
3. A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the SEC or IRS). (Reg. § 1.263(a)-1(f)(4))

Property ineligible for de minimis safe harbor election. Amounts paid for any of the following are ineligible for the de minimis safe harbor election:

…property that is or is intended to be included in inventory;
…land;
…rotable, temporary, and standby emergency spare parts that the taxpayer elects to capitalize and depreciate under Reg. § 1.162-3(d); and
…rotable and temporary spare parts that the taxpayer accounts for under the optional method of accounting for rotable parts under Reg. § 1.162-3(e). (Reg. § 1.263(a)-1(f)(2))

FAQs shed new light on de minimis safe harbor election. IRS’s new FAQs on the tangible property regs, along with recently released Rev Proc 2015-20, 2015-9 IRB (see Weekly Alert ¶  33  02/19/2015), provide new details on the mechanics and application of the de minimis safe harbor election.

Taxpayers without AFS. IRS’s FAQs explain that a taxpayer without an AFS is not required to have a written accounting procedure at the beginning of its tax year to qualify for the de minimis safe harbor election in that year. However, the taxpayer must expense amounts on its books and records for the tax year in accordance with a consistent accounting procedure or policy existing at the beginning of the tax year.

Flexibility in dollar ceilings. The preamble to the final regs said that if examining agents and a taxpayer agree that certain amounts in excess of the de minimis safe harbor limits are not material or otherwise should not be subject to review, that agreement should be respected, notwithstanding the requirements of the de minimis safe harbor. However, the preamble makes it clear that a taxpayer seeking a deduction for amounts in excess of the $5,000/$500 amounts allowed by the safe harbor has the burden of showing that such treatment clearly reflects income. (Preamble to TD9636, )

The new FAQs explain how this flexibility policy applies to a taxpayer that (1) doesn’t have an AFS, but (2) does have a policy for its books and records of deducting the costs of acquiring or improving tangible property less than a specified dollar amount, but exceeding the de minimis safe harbor ceiling of $500. The FAQs say that a taxpayer in this situation may properly deduct these amounts for federal tax purposes—even if they exceed $500—as long as it can show that the reporting policy clearly reflects its income.

The FAQs do, however, add that a taxpayer in the above situation may want to elect the de minimis safe harbor for items costing $500 or less to assure that the deduction of the items costing $500 or less won’t be questioned by IRS.

Amounts in excess of de minimis dollar limit. The FAQs clarify that taxpayers that make the de minimis safe harbor election don’t necessarily have to capitalize all expenses that exceed the $500 or $5,000 limits. Amounts paid for the acquisition or production of tangible property that exceed the dollar limits simply aren’t subject to the de minimis safe harbor election. If an amount doesn’t qualify under the de minimis safe harbor, it should be treated under the normal rules that apply. For example, it may be currently deductible if paid for incidental materials and supplies or for repair and maintenance. This treatment is proper regardless of whether the amount exceeds the applicable de minimis safe harbor dollar limit.

The FAQs stress that the de minimis safe harbor is simply an administrative convenience that generally allows a taxpayer to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules.

De minimis safe harbor not an accounting method change. The FAQs make clear that the de minimis safe harbor break is an annual election, made by attaching a statement titled “Section 1.263(a)-1(f) de minimis safe harbor election” to the timely filed original federal tax return including extensions for the tax year in which the de minimis amounts are paid. The statement should include the taxpayer’s name, address, and Taxpayer Identification Number (TIN), as well as a statement that it is making the de minimis safe harbor election. Under the election, the taxpayer must apply the de minimis safe harbor to all expenditures meeting the criteria for the election in the tax year.

As an annual election, the de minimis safe harbor break is not a change in accounting methods. Therefore, the taxpayer should not file Form 3115, Application for Change in Method of Accounting, to use the de minimis safe harbor for a particular tax year. Similarly, a taxpayer should not file a Form 3115 to stop applying the de minimis safe harbor for a subsequent tax year.

Like the preamble to the final regs, the FAQs make it clear that a taxpayer should not file a Form 3115 to change the amount it deducts under its book policy. For example, if a taxpayer’s written financial accounting capitalization policy at the beginning of 2014 says amounts paid for property costing less than $200 will be treated as an expense, and the taxpayer changes its written policy as of the beginning of 2015 to treat amounts paid for property costing less that $500 as an expense, the taxpayer is not required to file an application for its 2015 tax year to change its method of accounting.

References: For de minimis safe harbor election allowing deduction for amounts paid to acquire or produce property, see FTC 2d/FIN ¶  L-5601.5  ; United States Tax Reporter ¶  2634.01  ; TaxDesk ¶  256,201.2C  ; TG ¶  16074  .