Historically, many taxpayers have expensed the cost of tangible property that they acquired, produced, or improved if the property’s cost was less than a certain dollar threshold (the de minimis rule). These taxpayers generally determined their threshold amount by conforming to their financial accounting policy for expensing assets. However, because of a desire for increased certainty and uniformity among taxpayers, taxpayers requested that the government provide guidance that specifically included a de minimis rule for federal income tax purposes. As a result, the IRS began considering whether a de minimis rule was appropriate.
The IRS recently re-proposed regulations under Sec. 263(a) regarding the treatment of amounts paid to acquire, produce, or improve tangible property (REG-168745-03) and withdrew its earlier proposed regulations from 2006. The new regulations are proposed to apply to tax years beginning on or after the date final regulations are published.
The 2006 proposed regulations did not provide for a de minimis rule. However, in the preamble, the IRS outlined the rule it would have written and requested comments on whether a de minimis rule should be provided. Under the suggested rule, if a taxpayer had written accounting procedures that treated an amount paid for tangible property costing less than a specified dollar amount as an expense on its applicable financial statements (AFS)—e.g., SEC Form 10-K, Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, or certified audited financial statements—and treated such amount paid during the year as an expense on its AFS, then the taxpayer would not have been required to capitalize the amount.
Response to 2006 Proposed Regs.
In response, commentators noted that a de minimis rule would help strike a balance between the clear reflection of income standard and the costs and burdens of complying with and administering the tax law. Commentators also noted that a de minimis rule would formalize current examination practices that use risk analysis and materiality factors to minimize controversies with taxpayers over minor issues. Finally, because of the book-tax tension that exists with respect to a de minimis rule, commentators suggested that, at a minimum, a taxpayer should be permitted to deduct the amount specified in, and deducted under, its AFS policy. Because financial statement earnings tend to err on the side of conservatism and generally reflect a lower threshold for expensing an asset, adoption of a taxpayer’s AFS threshold should clearly reflect a taxpayer’s income for federal income tax purposes.
2008 Proposed Regs.
The new 2008 proposed regulations provide a de minimis rule for the acquisition or production of tangible property. In effect, the rule would not require a taxpayer to capitalize an amount paid for the acquisition or production of a unit of property (as defined in Prop. Regs. Sec. 1.263(a)3(d)(2)) if the following requirements are met:
- The taxpayer has an AFS;
- At the beginning of the tax year, the taxpayer has written accounting procedures that treat an item as an expense for nontax purposes to the extent the item costs less than a specified dollar amount;
- The taxpayer treats the amount paid during the tax year as an expense on its AFS in accordance with its written accounting procedure; and
- The total aggregate of such amounts paid and not capitalized does not distort taxable income.
The 2008 proposed regulations further provide a safe-harbor calculation that, if satisfied, would not consider the amount deducted by a taxpayer in accordance with the de minimis rule as distorting taxable income. A taxpayer would satisfy the safe harbor if the amount deducted under its de minimis rule, when added to the amount deducted for materials and supplies in accordance with Prop. Regs. Sec. 1.162-3(d)(1)(iii) (relating to property costing $100 or less), does not exceed the lesser of
- 0.1% of the taxpayer’s gross receipts for the tax year, or
- 2% of the taxpayer’s total depreciation and amortization expense for the tax year as determined in its AFS.
In the preamble to the 2008 proposed regulations, the IRS states that the purposes of the new de minimis rule are to reduce compliance burdens and provide simplification and that the IRS recognizes that accounting for an item using GAAP generally will not result in a distortion of income. Further, the preamble notes that the de minimis rule is not intended to alter the general risk analysis currently employed by examining agents; thus, the de minimis rule should not affect any current understanding between examining agents and taxpayers with respect to the size and character of transactions that are the focus of examinations.
Risk, Materiality, Burden, and Controversy
Based on commentators’ responses to the 2006 proposed regulations, a de minimis rule is a step in the right direction in providing taxpayers the certainty required in today’s regulatory environment. However, the 2008 proposed regulations may not succeed fully in meeting the goal of reducing burdens and achieving certainty.
As noted previously, the 2008 proposed regulations would require a taxpayer to have an AFS and written accounting procedures that provide for expensing assets costing less than a specified dollar threshold. In addition, the taxpayer would be required to expense the item in its financial statements in accordance with these procedures. Had the 2008 proposed regulations stopped at those requirements—effectively, a book-tax conformity standard—taxpayers would have rules that likely would clearly reflect taxable income and provide certainty. Instead, the incorporation of the fourth requirement in the 2008 proposed regulations—that the total aggregate of amounts paid and not capitalized does not distort taxable income—introduces a subjective test that, in effect, would override the previous requirements and create significant uncertainty for taxpayers.
The incorporation of this fourth requirement would require a tax-payer to defend its AFS deduction as not distorting taxable income using a facts-and-circumstances analysis. A taxpayer that chooses not to use this analysis could instead go through the burdensome process of computing the safe harbor to determine whether the amount deducted under the de minimis rule satisfies the safe-harbor requirements. Because the safe harbor cannot be computed until the end of the tax year (because it is based on an annual amount), the taxpayer would face uncertainty for financial reporting and corporate estimated tax purposes until year end. For these reasons, in order to provide a de minimis rule that is not burdensome and provides certainty and simplification, in the final regulations, the government should consider dropping the fourth requirement for a taxpayer with an AFS.
Regardless of whether the final regulations modify the de minimis rule included in the 2008 proposed regulations, it is likely that the final regulations will have an element of financial statement conformity with respect to the de minimis rule. Accordingly, taxpayers should work quickly to ensure they have written accounting policies in place to comply with the requirements noted above. In acting now, taxpayers would have the required policies in place at the beginning of the year when the regulations become final.
Annette B. Smith is with Washington National Tax Services PricewaterhouseCoopers LLP in Washington, DC
Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.
If you would like additional information about these items, contact Ms. Smith at (202) 414-1048 or email@example.com.