De Minimis Calculation Example

[Eustacio Gadit]

Section162 of the Internal Revenue Code (IRC) allows you to deduct all the ordinary and necessary expenses you incur during the taxable year in carrying on your trade or business, including the costs of certain materials, supplies, repairs, and maintenance. However, section 263(a) of the IRC requires you to capitalize the costs of acquiring, producing, and improving tangible property, regardless of the size or the cost incurred. The tax law has long required you to determine whether expenditures related to tangible property are currently deductible business expenses or non-deductible capital expenditures. Before the issuance of the final tangible property regulations on Sept. 17, 2013, [Treasury Decision 9636 ("final tangibles regulations")], your decisions were guided by decades of often conflicting case law, as well as administrative rulings on specific factual situations.

The final tangibles regulations combine the case law and other authorities into a framework to help you determine whether certain costs are currently deductible or must be capitalized. The final tangibles regulations also contain several simplifying provisions that are elective and prospective in application (for example, the election to apply the de minimis safe harbor, the election to utilize the safe harbor for small taxpayers, and the election to capitalize repair and maintenance costs in accordance with books and records).

The final tangibles regulations apply to anyone who pays or incurs amounts to acquire, produce, or improve tangible real or personal property. These regulations apply to corporations, S corporations, partnerships, LLCs, and individuals filing a Form 1040 or 1040-SR with Schedule C, E, or F. The final tangibles regulations affect you if you incur amounts to acquire, produce or improve tangible real or personal property in carrying on your trades or businesses. The rules are most significant for those that regularly incur large capital expenditures, e.g., electric utilities, telecommunications companies, and businesses with substantial real estate holdings. The final tangibles regulations are effective for taxable years beginning on or after Jan. 1, 2014. There are many examples in the final tangibles regulations to illustrate the application of these new provisions.

The final tangibles regulations apply equally to all businesses subject to U.S. tax law, regardless of for-profit or exempt status, organization size, legal entity, or industry. Nonprofits that pay unrelated business income tax, have taxable subsidiaries, or lose their tax exempt status need to consider the effect of these final tangibles regulations and determine if there is a change to current methods of calculating taxable income and deductions.

Under the final tangibles regulations, you may elect to apply a de minimis safe harbor to amounts paid to acquire or produce tangible property to the extent such amounts are deducted by you for financial accounting purposes or in keeping your books and records. If you have an applicable financial statement (AFS), you may use this safe harbor to deduct amounts paid for tangible property up to $5,000 per invoice or item (as substantiated by invoice). If you don't have an AFS, you may use the safe harbor to deduct amounts up to $2,500 ($500 prior to Jan. 1, 2016) per invoice or item (as substantiated by invoice).

These limitations are for purposes of determining whether particular expenses qualify under the safe harbor; they aren't intended as a ceiling on the amount you can deduct as business expenses under the IRC.

The de minimis safe harbor election does not include amounts paid for inventory and land. Additionally, it does not apply to rotable, temporary, and standby emergency spare parts that the taxpayer elects to capitalize and depreciate under 1.162-3(d). It does not apply to rotable and temporary spare parts that the taxpayer accounts for under the optional method of accounting under 1.162-3(e).

Neither the IRC nor prior regulations included a de minimis safe harbor exception to capitalization; you were required to determine whether each expenditure for tangible property, regardless of amount, was required to be capitalized. The de minimis safe harbor election eliminates the burden of determining whether every small-dollar expenditure for the acquisition or production of property is properly deductible or capitalizable. If you elect to use the de minimis safe harbor, you don't have to capitalize the cost of qualifying de minimis acquisitions or improvements. However, de minimis amounts you pay for tangible property may be subject to capitalization under 263A, if the amounts include the direct or allocable indirect costs of other property you produced or acquired for resale. For example, you must capitalize all the direct and allocable indirect costs of constructing a new building.

No. Amounts paid for the acquisition or production of tangible property that exceed the safe harbor limitations aren't subject to the de minimis safe harbor election. Therefore, the safe harbor doesn't require you to capitalize all amounts paid for tangible property in excess of the applicable limitation. If an amount doesn't qualify under the de minimis safe harbor, you should treat the amount under the normal rules that apply, i.e., currently deductible if paid for incidental materials and supplies or for repair and maintenance. This treatment is proper regardless of whether the amount exceeds the applicable de minimis safe harbor limitation. The de minimis safe harbor is simply an administrative convenience that generally allows you to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules.

An AFS includes a financial statement required to be filed with the SEC, as well as other types of certified audited financial statements accompanied by a CPA report, including a financial statement provided for a loan, reporting to shareholders, or for other non-tax purposes. An AFS also includes a financial statement required to be provided to a federal or state government or agency other than the IRS or the SEC.

If you don't have an AFS, you are not required to have written accounting procedures; however, you must expense amounts on your books and records for the taxable year in accordance with a consistent accounting procedure or policy existing at the beginning of the taxable year. If you have AFS, you must have the accounting procedures in writing.

If you don't have an AFS and have a policy for your books and records of deducting amounts more than $2,500 ($500 prior to Jan. 1, 2016), you may properly deduct these amounts for federal tax purposes, as long as you can show that your reporting policy clearly reflects your income.

You should attach a statement titled "Section 1.263(a)-1(f) de minimis safe harbor election" to the timely filed original federal tax return including extensions for the taxable year in which the de minimis amounts are paid. The statement should include your name, address, and Taxpayer Identification Number, as well as a statement that you are making the de minimis safe harbor election. Under the election, you must apply the de minimis safe harbor to all expenditures meeting the criteria for the election in the taxable year. For more information, see When and how do you make an election provided under the final tangibles regulations?

An annual election is not a change in method of accounting. Therefore, you should not file Form 3115, Application for Change in Method of Accounting, to use the de minimis safe harbor for a particular tax year, and you should not file a Form 3115 to change the amount you deduct under your book policy. Similarly, you should not file a Form 3115 to stop applying the de minimis safe harbor for a subsequent tax year.

In general, when you elect the de minimis safe harbor, materials and supplies that also qualify under your de minimis safe harbor are treated as de minimis costs and are not treated as materials and supplies. However, the de minimis safe harbor doesn't change your ability to deduct costs for materials and supplies, incidental or non-incidental, that don't qualify under the de minimis safe harbor.

Similarly, the de minimis safe harbor doesn't change your ability to deduct repair and maintenance costs that don't qualify under the de minimis safe harbor, for example, costs that exceed the safe harbor threshold. Therefore, for costs that don't qualify under the de minimis safe harbor, you apply the general rules for identifying and deducting repair and maintenance costs, incidental supplies, and non-incidental materials and supplies.

Inventory that you are accounting for as non-incidental materials and supplies under IRC 471(c) (for years beginning after Dec. 31, 2017, Revenue Procedure 2001-10 PDF or Revenue Procedure 2002-28 PDF for years beginning prior to Jan. 1, 2018) are still characterized as inventory and not subject to the de minimis safe harbor election. These two revenue procedures allow qualifying small business taxpayers to remain on the cash method even though they have inventory and to account for their inventory as non-incidental materials and supplies.

In most cases, the final tangibles regulations don't change the general rules for deducting materials and supplies. The final tangibles regulations merely incorporate pre-existing precedents on the definition and treatment of materials and supplies and add some safe harbors to provide you with additional certainty. The final tangibles regulations also provide additional elections and methods for those using rotable spare parts.

Because the final tangibles regulations governing the treatment of materials and supplies are based primarily on prior law, if you were previously in compliance with the rules you generally will still be in compliance and generally no action will be required to continue to apply these rules on a prospective basis.

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