New Tangible Property Safe Harbor
Recently the de minimis safe harbor provision was changed by the IRS for tangible property. This conversation will explain what that means for small businesses and what steps business owners should take to benefit from the change.
The Internal Revenue Code (IRC) provides guidance on how businesses should treat business income and expenses. In particular, Section 162 allows businesses to deduct expenses a business incurs in carrying its trade. However, an additional section [263(a)] requires a business “to capitalize the costs of acquiring, producing, and improving tangible property, regardless of the size or the cost incurred.” Think of tangible property as those things that we produce or acquire that have a life outside of a year; they are not immediately consumable. Tangible property also does not include items such as patents, copyrights, trademarks, or intellectual property.
That starts to sound pretty complicated and managed just as I have previously described, it would be. Businesses literally would have to capitalize and depreciate all tangible property. The cost of this exercise would be prohibitive. However, the IRC provided a safe harbor which allows businesses to expense tangible property up to a certain amount. For the purpose of our conversation, I am going to focus on small businesses. In the IRC, these businesses are defined as those without an applicable financial statement (AFS), which is generally an audited financial statement. Most small businesses do not have this. With that framework in mind, let’s dig a little deeper into a safe harbor.
WHAT IS THE SAFE HARBOR?
A safe harbor is a provision in a regulation that allows for protection to those parties that follow specific guidelines. Put simply, safe harbors keep us out of trouble so long as we do exactly what has been asked of us. When a business elects to utilize the safe harbor provision for tangible property, it is able to expense (immediately deduct) tangible property that is acquired or produced up to a certain threshold.
Previously for smaller businesses (without an AFS) that threshold was $500. In Notice 2015-82 issued by the IRS, the threshold has been raised effective for taxable years beginning on or after January 1, 2016. The new amount for smaller businesses is $2,500.
is a sizable change that can produce tremendous benefits including providing more immediate relief to the taxable income of a business.
HOW DOES THE SAFE HARBOR IMPACT MY BUSINESS?
So how exactly does the safe harbor impact a business? Let’s take a real life example. Let’s say that you purchased a laptop for your business costing $1,000. Under the old threshold you would have had to capitalize and depreciate that laptop. In other words, you were not able to take the full tax deduction in the year you bought the laptop because it was over the safe harbor de minimis. You would have spread that deduction over a few years; the expected life of the laptop. Starting in January 1, 2016, you will be able to fully deduct that laptop in the year it was purchased.
You may be asking, “Why is Michael telling me this now?” Great question. The IRS added a little kicker to this recent notice which basically says if we elect to use the new de minimis and follow their instructions, they will allow audit protection for early adopters.
plain English that means we can start using the new threshold now and they will not audit us on this topic. Merry Christmas!
WHAT DO I NEED TO DO?
The guidelines for smaller businesses (non-AFS businesses) are pretty straight forward. All they ask us to do is attach a statement titled “Section 1.263(a)-1(f) de minimis safe harbor election” to our timely filed original federal tax return including extensions for the taxable year in which the de minimis amounts are paid. The statement should include our name, address, and Taxpayer Identification Number, as well as a statement that we are making the de minimis safe harbor election. Wow – that’s pretty simple right?
The topic of tangible property and safe harbors can be a little intimidating. And electing the safe harbor may not be in the best interest of every small business. It is important to work with a qualified tax professional that can not only understand these types of provisions, but break them down to you in a way you can understand. I urge you to find a professional that works for your style. Provisions like the one we discussed today have great benefits to business owners.