The IRS recently issued final tangible personal property tax regulations that provide for new rules regarding when expenditures must be capitalized. These new rules will ultimately affect your business and are effective for tax years beginning on or after January 1, 2014. The complexity associated with implementation will vary but will be largely influenced by the investment you have in property, plant and equipment and real estate.
What expenditures are impacted? The new regulations address four main areas:
- Materials and Supplies
- Acquisitions of Tangible Property
- Improvements to Tangible Property
- Dispositions of Tangible Property
In addition, the new rules introduce a de minimis rule for materials and supplies and for amounts paid for the acquisition of tangible property. Under this rule, amounts paid for items costing less that a de minimis amount can be written off for tax purposes. There is also a routine maintenance safe harbor and a special small business de minimis rule for buildings in the final regulations. Perhaps the most important new concept concerns the treatment of structural components of real property and the ability to deduct a loss on the disposition of certain structural components.
What must be done right now?
For those companies that have audited financial statements and wish to avail themselves of the de minimis rules above, a written capitalization policy must be in place by January 1, 2014. The written policy must provide that amounts paid for items costing less than a certain dollar amount or with an economic useful life of 12 months or less will be treated as an expense for book purposes. The amounts that are protected under this de minimis safe harbor are limited to $5,000 per invoice or detailed item on an invoice. Amounts expensed in excess of this limit may still be deductible if the taxpayer can show that such treatment clearly reflects income. For companies without an audited financial statement, the new law lowers the safe harbor to $500 and the policy does not need to be in writing. However, we recommend that you have a written policy in place.
Taxpayers will have to compare their current methods of accounting with the new regulations and file accounting method change applications, where appropriate in order to be in compliance with the new rules. In addition, some of the new rules can be adopted by annual elections. For required accounting method changes, there is a three-year window for obtaining automatic approval (tax years beginning in 2012, 2013 and 2014). After that, taxpayers will be required to request permission to change accounting methods, which could prove to be more costly than the automatic approach. Also, the IRS has indicated that it will aggressively audit taxpayer compliance with the new regulations after 2014. Commentators have indicated that failure to file for accounting method changes may increase your chances of being audited. Finally, filing the appropriate accounting method changes provides you with audit protection for all open years. The benefit of audit protection is that the IRS is not allowed to examine the issue for all open tax years. Failing to properly implement the new regulations exposes you to a high level of audit risk, additional expense, as well as potential penalties for not being in compliance.
Virtually all taxpayers that acquire, produce or improve tangible property are going to be impacted by these regulations in some way. These new rules do not necessarily follow the GAAP rules so taxpayers may need to perform an analysis to see where they may diverge from their book accounting treatment. Many taxpayers will need to file accounting method change applications in order to take advantage of, and become compliant with, these new rules.
Adopted from 12/22/13 CBIZ MHM LLC author Mike DeSiato