If your business regularly purchases products like personal computers, small equipment or mobile devices, you’ll be happy 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.”
What are the benefits?
The safe harbor simplifies accounting and eliminates the need to decide 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 typically is 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 it won’t challenge the use of the $2,500 safe harbor for years before 2016, as long as the taxpayer has satisfied other safe harbor requirements.
The change was designed to ease the recordkeeping required to comply with capitalization rules. The previous safe harbor limit of $500 was so low that many items most businesses regularly purchase still required capitalizing. Thus, it did little to ease the administrative work many small businesses faced in complying with capitalization requirements.
What are the requirements?
To take advantage of the de minimis safe harbor, the following requirements must be met:
- The amount deducted must be for ordinary and necessary business expenses, and
- The business must expense the 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 expense some and capitalize others.
The safe harbor election doesn’t, however, apply to purchases of inventory, some spare parts and land. For instance, the direct and allocable indirect costs of constructing a new building must be capitalized.
But businesses may claim deductible repair and maintenance costs that exceed the $2,500 threshold under the tangible property rules that apply to those types of expenses.
How can you use it?
A business that elects to use the safe harbor will need to attach a statement, “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 should include the company’s name, address and Taxpayer Identification Number and should note that it is making the safe harbor election.
The election doesn’t constitute a change in a company’s method of accounting, so it’s not necessary to file Form 3115, “Application for Change in Accounting Method.” Neither is it necessary to file this form to change the amount deducted under the company’s book policy. It’s also not necessary to file it to stop applying the safe harbor for a subsequent tax year.
For costs that don’t qualify under the safe harbor, the business still applies the general rules for identifying and deducting costs for repairs and maintenance as well as materials and supplies. If a business without an applicable financial statement has had a policy of deducting amounts spent to acquire and improve tangible property that exceed $2,500, it can properly deduct those amounts for federal tax purposes, as long as it shows that its reporting policy clearly reflects its income. But the IRS advises in “Tangible Property Regulations — Frequently Asked Questions” that electing the safe harbor for items costing no more than $2,500 likely will reduce the risk of IRS questions.
How can you simplify?
Businesses that don’t have applicable financial statements will want to revisit their policies for capitalizing purchases of tangible property, given the higher de minimis safe harbor. Those that have been capitalizing purchases of less than $2,500 may find they can streamline their processes and simplify their recordkeeping by taking advantage of the higher safe harbor limit. Your accounting professional can provide more information on the safe harbor and how it might apply to your business.
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.