Expenses & Deductions
The final tangible property regulations (T.D. 9636) issued in September 2013 provided guidance for taxpayers to elect a minimum capitalization threshold, otherwise known as the de minimis safe harbor. The safe harbor allows taxpayers to set a minimum capitalization amount under which amounts are not capitalized. Eligible taxpayers must:
- Have an applicable financial statement;
- Have at the beginning of the tax year written accounting procedures treating as an expense for nontax purposes amounts costing less than a specified dollar amount or amounts paid for property with an economic useful life of 12 months or less;
- Treat such amounts as expenses on its applicable financial statement in accordance with its written accounting procedures; and
- Apply the expense treatment only to amounts paid for property that do not exceed $5,000 per invoice (or per item as substantiated by the invoice).
Taxpayers without an applicable financial statement are also eligible for the de minimis safe harbor. However, the threshold amount is reduced to $500 per invoice or item, and the accounting procedures are not required to be in writing.
The de minimis safe harbor is one of the areas of the regulations where taxpayers have significant questions. Below are some of the most frequently asked questions:
Q: What costs are deductible under the de minimis safe harbor?
A: The de minimis safe harbor applies to amounts paid for property otherwise required to be capitalized under Regs. Sec. 1.263(a)-2(d)(1) (acquired or produced tangible property) or Regs. Sec. 1.263(a)-3(d) (improvements of tangible property) or required to be treated as a material or supply under Regs. Sec. 1.162-3(a). Further, amounts not deductible as de minimis expenses (i.e., amounts larger than the de minimis threshold) may still be deductible under other Code sections, such as those for deductible repairs and maintenance.
Q: Are written capitalization procedures required by every business electing the de minimis safe harbor?
A: The de minimis procedures are not required to be in writing if the taxpayer does not have an applicable financial statement and is applying the lower $500 de minimis threshold. If the taxpayer has an applicable financial statement and intends to apply a threshold greater than $500 but less than $5,000, the accounting procedure must be in writing. A best practice, however, is to document these procedures in writing.
Q: How is the de minimis election made?
A: The election is made by attaching a statement to a timely filed original federal tax return (including extensions) for the tax year in which the amounts are paid. The statement must be titled "Section 1.263(a)-1(f) de minimis safe harbor election" and include the taxpayer's name, address, and taxpayer identification number, and a statement that the taxpayer is making the de minimis safe-harbor election under Regs. Sec. 1.263(a)-1(f). In the case of affiliated groups of corporations filing a consolidated return, the election statement must include the names and identification numbers of each member making the election. Taxpayers are not required to attach the written de minimis policy to the tax return.
Q: Is the de minimis safe-harbor election revocable, and what is the effective time frame for making the election?
A: The de minimis safe-harbor election must be made annually. Once made, the election is irrevocable for the tax year elected. The de minimis safe-harbor election can be made for tax years 2012 and 2013; however, de minimis capitalization procedures must be in place at the beginning of the respective tax year.
Q: Can an election to apply the de minimis safe harbor be made through filing an application for change in accounting method?
A: No, the election cannot be made through filing an application for change in accounting method.
Q: How is the asset or item identified to apply the de minimis expensing amount?
A: The de minimis safe-harbor amount is applied to the invoice price (or item price as substantiated on the invoice) of the property that is generally acquired or produced as a single unit of tangible property. The anti-abuse rule in Regs. Sec. 1.263(a)-1(f)(6) prohibits any attempt by the taxpayer to manipulate transactions to reduce individual invoice amounts for a single unit of tangible property to an amount less than the de minimis expensing threshold.
Q: What is the difference and applicability of the terms "per item" and "per invoice" in the de minimis safe-harbor rules?
A: "Per item" refers to an acquisition of property that may include multiple items, i.e., a bulk purchase. The de minimis safe harbor is applied at the invoice level first. However, if the invoice is for the purchase of multiple items, i.e., separate units of property, the de minimis safe harbor can be applied to each item if the invoice substantiates the items included on the invoice.
Q: Can a threshold greater than $500 or $5,000 be used for the de minimis safe harbor?
A: The de minimis safe harbor is limited to $500 (without an applicable financial statement) or $5,000 (with an applicable financial statement). However, the preamble to the regulations states that the safe harbor does not preclude a taxpayer from reaching an agreement with its IRS examining agents that, as an administrative matter, based on risk analysis or materiality, the IRS examining agents will not review certain items. However, a taxpayer that seeks a deduction for amounts in excess of the amount allowed by the safe harbor has the burden of showing that such treatment clearly reflects income. A taxpayer that intends to follow a capitalization threshold higher than the $500 or $5,000 safe-harbor limits, as applicable, will not meet the de minimis safe harbor and will not be eligible to make the election.
Q: If a taxpayer wishes to follow a capitalization amount higher than the de minimis safe harbor limits, how can the taxpayer demonstrate that its capitalization policy clearly reflects its income?
A: A taxpayer's conformity with GAAP in a particular trade or business in accordance with accepted conditions or practices in that trade or business will ordinarily be regarded as clearly reflecting income (Regs. Sec. 1.446-1(a)(2)). However, there is no presumption that GAAP and tax accounting methods must be equal, and taxpayers should also consider whether the current method appropriately matches income and related expenses.
Q: Will the de minimis policy of a publicly traded foreign company apply for its U.S. subsidiary?
A: The de minimis policy will apply for the U.S. subsidiary when the foreign parent has an applicable financial statement issued with the audit report of the equivalent of an independent CPA, the foreign parent follows its written de minimis policy on its applicable financial statement, and the U.S. subsidiary's results are reported on the foreign parent's applicable financial statement.
Q: Does a compilation or a review of financial statements qualify as an applicable financial statement?
A: No, neither a compilation nor a review of financial statements satisfies the criteria to be an applicable financial statement.
Q: Do financial statements submitted to a municipal or local government agency qualify as an applicable financial statement?
A: An applicable financial statement includes a financial statement (other than a tax return) required to be provided to a federal or state government or any federal or state agency (other than the IRS or SEC). The IRS has not expounded on this definition to clarify what exactly qualifies as, for example, an agency of state government for these purposes. Until guidance is published, taxpayers should not rely on financial statements submitted to governments or agencies that are not clearly federal or state governments or their agencies as qualifying as applicable financial statements.
Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Bethesda, Md.
For additional information about these items, contact Mr. Anderson at 301-634-0222 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with BDO USA LLP.