RE: New Capitalization Regulations - ACTION ITEM: Business taxpayers must have written accounting policies in place on the first day of the tax year (January 1, 2014 for calendar year taxpayers) to deduct the de minimis amounts provided under safe harbor provision.
Recently, the Internal Revenue Service issued final tangible property capitalization regulations. These regulations provide clarity to a complex area of tax law for business taxpayers who acquire tangible property or who own tangible property which they improve, maintain or repair. The final regulations address the proper characterization and tax treatment of expenditures related to these acquisitions, improvement, maintenance and repair activities.
Generally, under IRC Section 263(a), amounts paid to acquire, produce or improve tangible property must be capitalized. However, taxpayers are permitted to deduct ordinary and necessary business expenses, including the costs of certain supplies, repairs and maintenance under IRC § 162(a). It is often difficult to distinguish (1) between assets that must be capitalized and property that is a material or supply, and (2) between improvement costs and repair or maintenance costs. The finalized regulations attempt to clarify when such payments may be deducted and when they must be capitalized.
De Minimis Safe Harbor Election
A key provision in the final regulations is a revised safe harbor election that permits a deduction for de minimis amounts paid for tangible property. Under the safe harbor election, a taxpayer may elect to not capitalize (in other words, to currently deduct) specified amounts paid in the tax year to acquire or produce tangible property, provided the amounts don't exceed applicable thresholds. The amount of the threshold depends on whether the taxpayer has written accounting procedures in place and, if so, whether the taxpayer has an applicable financial statement.[i]
Taxpayers with an Applicable Financial Statement and Written Accounting Procedures
A taxpayer with an applicable financial statement may rely on the final regulations' safe harbor to expense an item in accordance with the taxpayer's written accounting policies it
[i] Reg § 1.263(a)-1(f)(4) defines an applicable financial statement as the taxpayer's financial statement with the highest priority. Those with the highest priority are listed first: (1) financial statement required to be filed with the SEC; (2) audited financial statements used for credit purposes; (3) audited financial statements used to report to shareholders, partners or similar persons; (4) audited financial statements used for another substantial non-tax purpose; or (5) a financial statement (not a tax return) required to be provided to the federal or state government or any federal or state agency. Note: Presumably, reviewed, compiled or taxpayer-prepared financial statements not reported on by CPAs would only be considered applicable financial statements if required to be provided to government entities.
SAMPLE CAPITALIZATION POLICY
This accounting policy establishes the minimum cost (capitalization amount) that shall be used to determine the capital assets to be recorded in 's books and financial statements.
- Capital Asset Definition and Thresholds
A "Capital Asset" is a unit of property with a useful life exceeding one year and a per unit acquisition cost exceeding . Capital assets will be capitalized and depreciated over their useful lives. will expense the full acquisition cost of tangible personal property below these thresholds in the year purchased.
- Capitalization Method and Procedure
All Capital Assets are recorded at historical cost as of the date acquired.
Tangible assets costing below the aforementioned threshold amount are recorded as an expense for 's annual financial statements (or books). In addition, assets with an economic useful life of 12 months or less must be expensed for both book and financial reporting purposes.
Invoices substantiating the acquisition cost of each unit of property are to be retained for a minimum of (<#>) years.
Tax Capitalization Threshold: The permissible ceiling for deducting otherwise capitalizable expenditures is $5,000 when our business has applicable financial statements. The threshold is limited to $500 in the absence of applicable financial statements.