If you’ve struggled with determining whether you must capitalize costs incurred in acquiring, maintaining, or improving tangible property under Internal Revenue Code Sections 162(a) and 263(a), you’re not alone.
Determining whether an expense can be deducted as a repair or must be capitalized has always been based on a particular taxpayer’s facts, requiring the taxpayer to rely on the subjective nature of the regulations.
The IRS recently released final regulations on the tax treatment of expenses related to tangible property. The new regulations offer taxpayers clarity and guidance on how to comply with IRC Sections 162(a) and 263(a).
Understanding the rules could mean tax savings for manufacturers.
Background
On December 27, 2011, the IRS and Treasury Department published temporary regulations in the Federal Register to clarify the rules between capitalizing and expensing costs under IRC Sections 162(a) and 263(a). On September 13, 2013, after considering all of the comments and the statements from public hearings regarding the temporary regulations, the Treasury Department issued final regulations, known as T.D. 9636.
The Who, What and When of T.D. 9636
T.D. 9636 is generally effective for taxable years beginning on or after January 1, 2014. Early adoption is allowed for taxable years beginning on or after January 1, 2012, with certain limitations.
The final regulations are 145 pages and cover a variety of topics. The de minimis safe harbor rules and the treatment of costs of materials and supplies have the greatest relevance for manufacturing and wholesale distribution companies.
De Minimis Safe Harbor
The final regulations adopt a new de minimis safe harbor that allows taxpayers to set a minimum capitalization threshold for amounts paid to acquire or produce a unit of real or personal property, including the related transaction costs.
The key requirements of the safe harbor are:
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Policy must be in writing by beginning of taxable year, as early as January 1, 2014
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Policy must specify that amounts will be expensed for non-tax purposes if the amounts are below a specified dollar amount
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Policy must be followed on taxpayer’s applicable financial statements
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Taxpayers with applicable financial statements can deduct for tax purposes amounts paid for property up to $5,000 per invoice
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Taxpayers without applicable financial statements can deduct for tax purposes amounts paid for property up to $500 per invoice
The de minimis safe harbor rule is elected annually by including a statement on the taxpayer’s original federal tax return, filed timely, for the year elected. Once made, the election can’t be revoked. The election may not be made by filing an application for change in accounting method.
Materials and Supplies
The 2011 temporary regulations defined materials and supplies to include property that has an acquisition or production costs of $100 less. Commenters at the hearings requested the $100 be raised to $500 or $1,000. Their concern was that the low $100 threshold would not capture many common supplies and that it would be burdensome to capitalize common office supplies costing over $100 and less than $500 or $1,000. The Treasury Department, in T.D. 9636, decided to increase the $100 threshold to $200, declining to increase it more, as they had concerns over distortions to income that could result from increasing the amount any higher.
The 2011 temporary regulations permitted a taxpayer to elect to capitalize and depreciate amounts paid for certain materials and supplies. The final regulations limit the election to rotable, temporary or standby emergency spare parts. Most significantly, if the taxpayer makes the de minimis safe harbor election discussed above, all materials and supplies must be treated as de minimis expenses, except where the taxpayer elects to capitalize and depreciate rotable, temporary or standby emergency parts.
Taxpayers need to determine how the new rules clarified in T.D. 9636 may affect their methods of accounting for materials and supplies along with their overall capitalization policy for amounts paid to acquire or produce a unit of real or personal property.
There are tax planning opportunities that allow taxpayers to accelerate or slow deductions. Since there are tax elections in the final regulations that are dependent on financial reporting methods used, taxpayers should begin the planning process NOW.
Moving Forward
If your business has expenses related to tangible property, these final regulations affect you. Knowing the rules and how to apply them could mean tax savings for your business. And depending on your particular situation, you might need to take specific actions to comply with the final regulations.
Need Help?
If you are unsure whether your business is affected, or have questions about what you need to do to comply, contact us online or call 800.899.4623.
