** This article originally appeared in the November 15th issue of the Cincinnati Business Courier’s Supplement dedicated to the Goering Center for Family and Private Business.**
Discuss this finalized IRS guidance with a tax professional
In September the IRS issued finalized guidance on its laws regarding business’ ability to deduct certain expenses. And it’s likely the changes will require you to take action before the end of the year.
The IRS’s final tangible property regulations clarify the two code sections which govern the treatment of tangible property expenses. The guidance directs businesses when they can deduct expenses in the current year, and, alternatively, when they have to capitalize those expenses and spread the deduction out over several years.
A tale of two codes
Under §162(a), businesses have long been able to deduct ordinary and necessary expenses incurred in carrying on a trade or business, including the costs of certain supplies, repairs, and maintenance. Employee wages, your electricity bill, oil changes on your fleet vehicles and pencils have all been deductible expenses. However, under §263(a), costs incurred for the acquisition, production or improvement of tangible property must be capitalized over the life of the property.
So where do you draw the line? To many business owners these laws may appear to contradict each other. Isn’t a pencil an item of tangible property? Do I have to spread the 50 cents out over 5 years? How do I know which items can be expensed and which must be capitalized?
Prior to the release of the new regulations, the determination to deduct or capitalize was based on “the taxpayer’s particular facts and circumstances.” This of course led to controversy between taxpayers and the IRS in deciphering which “facts and circumstances” were appropriate for deducting expenses, and which were appropriate for capitalizing expenses.
Resolving controversy
With the new regulations in place, we now have specific guidelines for the treatment of these costs and several “safe harbors,” giving business owners a clear understanding as to which expenses are deductible and which must be capitalized. For some, the impact will be significant. Businesses which have erred on the conservative side of the “facts and circumstances” test, and possibly capitalized more expenses than necessary, may now be able to deduct significantly more costs, thereby reducing their taxable income.
Safe harbors
The regulations establish a de minimis safe harbor to allow businesses to deduct expenses to acquire or produce a unit of property under a certain threshold. For businesses with written accounting procedures in place at the beginning of the tax year, items costing $500 or less (or $5,000 for businesses with an applicable financial statement) are deductible if they are on separate invoices, or itemized separately on one invoice (including additional costs).
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The requisite accounting procedures must explain that the business treats as an expense (a) amounts paid for property costing less than a specified dollar amount, and/or (b) amounts paid for property with an economic useful life of 12 months or less. Also, the new regulations clarify that materials and supplies (such as the abovementioned pencil) that cost $200 or less are deductible in the year they are used or consumed, regardless of the accounting procedures or financial statements in place.The regulations also establish a safe harbor for small taxpayers with buildings wherein businesses with annual gross receipts of $10M or less can deduct expenses associated with the repair, maintenance, or improvement of a building if the total expenses do not exceed the lesser of (a) $10,000 or (b) 2% of the unadjusted basis of the building. The building can be owned or leased by the taxpayer and must have an unadjusted basis of $1M or less.
For a building you own, the unadjusted basis will essentially equal the purchase price. For a leased space, the unadjusted basis will equal the total rent you expect to pay over the entire lease term (including expected renewal periods). This safe harbor is applied separately to each building you own or lease.
Furthermore, a routine maintenance safe harbor is established which allows businesses to deduct costs for routine maintenance performed on a unit of property (including buildings and building systems) if it was reasonably expected that the maintenance would have to be performed more than once during the life of the unit of property, or 10 years for buildings (or building systems).
Strategic compliance
The effective date of the regulations is January 1, 2014, meaning that the regulations must be complied with on that date, but taxpayers have the option of applying portions of the regulations to tax years beginning on or after January 1, 2012.
It is important for business owners to meet with tax advisors as soon as possible before the end of the year to discuss the following:
1. Do I have expenses which were previously capitalized that now can be deducted under the new regulations?
2. If so, in which years did I incur those expenses and can I recoup costs from prior years?
3. Based on the types of property I typically purchase in my business, what written accounting procedures do I need to have in place to comply with the new regulations moving forward and to ensure that appropriate expenses are being deducted?
Being proactive about these changes could have a significant positive impact on your tax liability for this year, and possibly allow you to recoup costs from prior years.
For more information please contact Brendan Walsh, JD, MBA, at [email protected].
