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IRS Increases De Minimis Safe Harbor Expensing Threshold for Small Businesses

December 14, 2015
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After completing its review of public comments as to whether it was appropriate to increase the de minimis safe harbor threshold for taxpayers who don't have an applicable financial statement (AFS), IRS has raised the threshold from $500 to $2,500. The final tangible property regulations allowed the IRS to change the safe harbor limit to an amount identified in published guidance, and IRS believes that this increase furthers the goal of the final tangible property regulations to reduce administrative burden and that methods of accounting clearly reflect income. The revised safe harbor amount is effective for costs incurred during tax years beginning after 2015, but IRS has decided that it won't raise this issue on examination of pre-2016 tax years if a taxpayer satisfies other applicable requirements of the regulations.

Background
The final tangible property regulations provided guidance regarding when costs incurred to acquire, produce or improve tangible property, must be capitalized or may be deducted, and rules regarding full and partial dispositions of tangible depreciable property.
In addition to clarifying the treatment of the aforementioned costs, the tangible property regulations also include several simplifying provisions that are elective and applied prospectively with the intent being to ease taxpayers' compliance with the regulations and to reduce administrative burden. For example, the regulations provide a de minimis safe harbor election that permits a taxpayer to not capitalize, or treat as a material or supply, certain amounts paid for tangible property that it acquires or produces during the taxable year provided the taxpayer meets certain requirements and the property does not exceed certain dollar limitations. If such requirements are met, amounts paid for the qualifying property generally may be deducted provided the amount otherwise constitutes an ordinary and necessary business expense in carrying on a trade or business.  

Details
Under the final tangible property regulations, a taxpayer without an AFS, as defined in the regulations, may elect to apply the de minimis safe harbor if, in addition to other requirements, the amount paid for the property subject to the de minimis safe harbor does not exceed $500 per invoice (or per item as substantiated by the invoice). Whereas a taxpayer with an AFS may elect to apply the de minimis safe harbor if, in addition to other requirements, the amount paid for the property does not exceed $5,000 and the taxpayer treats the amount paid as an expense on its AFS in accordance with its written accounting policies. The IRS believes that the larger safe harbor limitation is reasonable for a taxpayer with an AFS (e.g., an audited financial statement) since an AFS provides independent assurance that the taxpayer's de minimis policies are consistent with the requirements of generally accepted account accounting principles ("GAAP") and do not materially distort the taxpayer's financial statement income.

The de minimis safe harbor is intended as an administrative convenience whereby a taxpayer is permitted to deduct small dollar expenditures for the acquisition or production of new property or for the improvement of existing property, which otherwise must be capitalized. The de minimis safe harbor does not limit a taxpayer's ability to deduct otherwise deductible repair or maintenance costs that exceed the amount subject to the safe harbor. The safe harbor just provides a minimum threshold below which all qualifying amounts are considered deductible. A taxpayer may continue to deduct all otherwise deductible repair or maintenance costs, regardless of amount.

Subsequent to the final tangible property regulations being issued, the Treasury Department and the IRS received numerous letters from representatives of small business taxpayers requesting that the Treasury Department and the IRS increase the de minimis safe harbor limit for taxpayers that do not have an AFS. As a result of this public outcry, the Treasury Department and the IRS formally requested comments on whether it is appropriate to increase the de minimis safe harbor limit for a taxpayer without an AFS to an amount greater than $500, and, if so, what amount should be used and the justification for considering that amount appropriate.

Well, after sifting through more than 150 comment letters, the IRS listened and decided to increase the de minimus safe harbor threshold from $500 to $2,500. A common theme in the letters was that the $500 limitation was too low to effectively reduce the administrative burden of complying with the capitalization requirement for small business taxpayers who frequently purchase tangible property in their trades and businesses. Commenters rightly pointed out that the cost of many commonly expensed items (for example, tablet-style personal computers, smart phones, and machinery and equipment parts) typically exceed the current $500 per item or invoice threshold provided in the regulations. Also mentioned was that the $500 threshold does not correspond to the financial accounting policies of many small businesses, which frequently permit the deduction of amounts in excess of $500 as immaterial and that without an increase in the safe harbor threshold a small business taxpayer would be left in a quandary of having to establish that its policy results in the clear reflection of income for federal income tax purposes, causing additional administrative burden and uncertainty for small business taxpayers.

Audit Protection
Although the revised safe harbor amount is effective for costs incurred during tax years beginning after 2015, the IRS has indicated in Notice 2015-82 that for taxable years beginning before January 1, 2016, the IRS will not raise upon examination the issue of whether a taxpayer without an AFS can utilize the de minimis safe harbor for an amount not to exceed $2,500 per invoice (or per item as substantiated by invoice) if the taxpayer otherwise satisfies the requirements of the regulations. In addition, the IRS will not further pursue the issue if the taxpayer's use of the de minimis safe harbor is an issue under consideration in examination, appeals, or litigation in a taxable year that begins after December 31, 2011, and ends before January 1, 2016, and the issue relates to the qualification under the safe harbor of an amount (or amounts) that does not exceed $2,500 per invoice (or per item as substantiated by invoice) and the taxpayer otherwise satisfies the requirements of the regulations.

Summary
With the issuance of Notice 2015-82, small business taxpayers without audited financial statements received a welcomed gift just in time for the holidays. The increased safe harbor threshold achieves the administrative convenience goal intended in the final tangible property regulations and will allow small businesses to immediately deduct many small dollar expenditures that would otherwise need to be capitalized and expensed over a period of years via annual depreciation deductions thereby enhancing their cash flow as well. Please contact Paul Helderman, or your Citrin Cooperman contact partner/director for further assistance and guidance with application of this new development.